Waiting for long-term economic policies

Christophe Donay, head of Asset Allocation & Macroeconomic Research

Waiting for long-term economic policies

Central bank dovishness, plus fiscal and budgetary stimulus could help prolong the current cycle. But more coordination is needed to put long-term growth on a firm footing.

Central banks around the world are busy easing monetary policy again, injecting new liquidity into markets in a bid to stimulate flagging growth and inflation rates. This is why, as in previous years, an imminent global recession is not our central scenario. Yes, global manufacturing is in the doldrums, but there are signs that the slowdown in global activity might be reaching a trough. The economic cycle, already the longest since World War Two in the US, could be prolonged.

Mario Draghi used the press conference following the latest European Central Bank (ECB) stimulus announcement in mid-September to call on governments with fiscal space "to act in an effective and timely manner". Indeed, there are stirrings on that front, with governments from London to Beijing starting to open the budgetary purse strings. The government of Emmanuel Macron is estimated to have injected EUR 25bn into the French economy since he took office in 2016, for example, with EUR 5bn in tax cuts in the offing. Faced with declining growth, voices are even being raised within Germany about the country’s rigid adherence to a balanced or surplus budget.

In general, we believe a greater concertation between monetary and fiscal experts to come up with fresh economic policies could produce more enduring results. There is still a chance for authorities in the West to pre-empt the risk of ‘Japanisation’—of decades-long low growth and inflation. But salvation will not come from stop-gap monetary measures or from a scatter-gun approach to spending public money. Instead, policy makers need to concentrate on encouraging investment and innovation, still the two main pillars of high-quality, self-sustaining growth.

“We believe a greater concertation between monetary and fiscal experts to come up with fresh economic policies could produce more enduring results.”

However, there are two problems to concertation: on the one hand, monetary policy, including quantitative easing, is becoming increasingly ineffective, with interest rates already so low and negative bond yields showing liquidity is abundantly available, it is not clear that the latest ECB’s policy moves will have an enduring impact. And as for fiscal/budgetary policy, in many leading economies, public debt is well over the 60% of GDP level, beyond which it becomes difficult to ease fiscal policy in any sustainable way. Setting the right priorities for the most productive allocation of capital is complex and takes time to implement, and is not aided by short-term political calculations.

Yet, by at least stabilising economic prospects at their current (low) level and dispelling the risk of an imminent recession, the latest stimulus moves should provide greater visibility for risk assets, helping valuations remain at their current high levels, or even push them higher. Earnings expectations for this year, which in the case of US equities have fallen dramatically, could stabilise. Finally, combined monetary and fiscal stimulus should help offset the negative effect of trade tensions.

As for fixed income, the downward pressure on yields exerted by central bank dovishness could be more than offset by rising fiscal stimulus. By helping dispel the fears of imminent recession, this could reverse the fall in long-term bond yields that for some time have been well below nominal growth (a powerful indicator of bonds’ fair value). While core government bonds will always have a protective role in portfolios, the prospect that they will play only a minor or negative role in generating performance needs to be taken into account in multi-asset portfolio allocation.

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