Financial markets have seen many of the principles that until then governed their operation blow up in the last decade. Interest rates – nominal – can reach negative levels, investors can pay to finance a State or a company and the stock markets can have a reason to rise in bad news, and vice versa.
“The worse the better” could be the motto of one of the most complex stages in the history of the global economy, in which the extraordinary action of large central banks has led to rewriting the rules of the markets. Nothing that has happened since the fall of Lehman Brothers until today could be understood without paying attention to the about 16 trillion dollars (more than 13.6 trillion euros) with which the Fed, the ECB, the Bank of Japan, the Bank of England, the Bank of China and many others around the world have flooded the world’s financial systems.
The fundamental role of central banks in the succession of records recorded by stocks or debt throughout these years has been such that investors have long preferred to ensure their continuity, even at the cost of a weaker economy. This is how the markets have been able to overcome enormously convulsive episodes such as the euro crisis, Brexit or the trade war with striking integrity and, in part, how they have been able to quickly leave behind the shocks caused by the coronavirus crisis.
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But this approach could be nearing its end. “We see little reason to be confident that the pattern we have seen of the past 10 years of ‘bad news is good news’ will continue, where markets anticipated responses from central banks that dominated macroeconomic realities. In the next three to five years years, it is very likely turning bad news on the macro front into bad news for risk assets“, defend the experts of the manager Pimco in a report published last September.
The idea is based on a perception that the market has been ruminating for several quarters and that the coronavirus crisis has only worsened: the capacity of central banks to act is practically exhausted and the marginal performance of their stimuli tends to decrease. low. “Investors are realizing that central banks are running out of ammunition and that economic growth should depend more on a recovery from the health crisis and, in the meantime, on new and more powerful stimuli, “says Patricia García, a partner at Macroyield.
The warnings that the former president of the European Central Bank (ECB), Mario Draghi, launched from his chair to convince governments to complement the institution’s efforts with a fiscal stimulus package to strengthen the recovery of the Eurozone. But it was necessary to wait for a critical situation such as that generated by the coronavirus for these appeals to find a forceful response, both in Europe, in the United States and in most global economies.
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Now, there are many voices calling for this economic paradigm shift – with governments leading a resounding shift from austerity policies towards an almost unrestricted fiscal expansion– extends beyond what is strictly necessary to combat the effects of the pandemic. Ultimately, they argue, the monetary stimulus policies of the last decade have been effective in boosting markets, but they have not yielded satisfactory results on the economic front, so overcoming the current difficulties and making way for a sustainable recovery should be based on in a fiscal impulse, which should be more effective in accelerating the economic cycle.
“A sustainable recovery requires broad support to the real economy, including individuals and small companies, “pointed out the head of macro strategy at Algebris Investment, Alberto Gallo, in an article published in ‘Bloomberg’. Initiatives such as the European economic recovery plan seem to adjust to these demands, with high hopes placed in its transformative potential – focusing on digital development and the energy transition – of an economy that has been showing signs of weakness for several years now.
The ‘Biden effect’
And in the same vein, a movement more favorable to the prospects of a resounding victory for the Democratic Party (the so-called “blue wave”) has developed in the United States in the elections on November 3, since Joe Biden’s candidacy is considered as more conducive to the development of massive fiscal boost plans for the real economy, through investments in infrastructure and public services.
“Simulations in our global economic model show that a Biden stimulus package could raise GDP growth by more than 2 percentage points to more than 5% next year“Gregory Daco, Oxford Economics’ chief US economist, suggests in a report.
A movement of this magnitude should obviously leave its mark on the markets and for weeks there has been speculation about the possibility of a wide rotation in the coming months, which allows some of the sectors (in essence, cyclicals) and investment styles (such as ‘value’) that have been disadvantaged by the conditions of recent years to recover ground.
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“Increased fiscal stimulus could have a positive impact on the more cyclical and value sectors, which will benefit from expectations of higher economic growth, while growth values begin to show signs of possible overvaluation and fatigue, “confirms Patricia García.
However, a fundamental problem looms over this possibility of a turnaround in the market: the coronavirus pandemic. In the midst of a wave of outbreaks, it seems very difficult to propose any acceleration of world growth, no matter how much fiscal stimulus is put on the table.
“For a change to take place that produces a pull of the ‘value’ or cyclical companies growth acceleration needs to be foreseen and inflation expectations are raised in the medium and long term. But as long as the pandemic continues to penalize the economic outlook, all that is going to be delayedr “, warns José Manuel Amor, managing partner of Afi’s Economic Analysis area.
In any case, Amor recalls, the change towards an economic model more based on fiscal stimuli does not imply, far from it, that the money of the central banks is going to stop playing a fundamental role in the economy and in the markets. Either ensuring, precisely, that States have the capacity to finance the deficits needed to boost their respective economies or providing stability to markets at levels justifiable by the abundance of current liquidity.
And this idea leads to the following paradox that the markets paradigm shift could bring. And it is that although it can be considered that the time of “the worse, the better” has come to an end, it is not so clear that good data will necessarily become good news for investors.
It must be taken into account that the policy of massive monetary stimuli has been favored by a scenario of persistent low inflation globally. But an acceleration in global growth that led to a surge in prices could make the job of central bankers much more complex. It cannot be ignored that in the United States, without going any further, long-term inflation expectations are already moving around its highest levels in nearly a year and a half.
If central banks were forced to retreat, no matter how much this responded to a positive evolution of the economy, there could be a sharp market adjustment, such as the one that already took place in 2013 –the episode known as ‘taper tantrum’– at the first signs that the Fed was planning to end its monetary stimulus policies.
It is true that after that episode of volatility, the US central bank eventually found a way to withdraw its extraordinary stimulus policies without derailing the markets. But now the situation becomes more complex because of the historical increase in debt – public and private – to which the coronavirus crisis has led and which multiplies the dependence of governments and companies on very lax financial conditions.
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That is why at Pimco they warn that the market is entering a more difficult and volatile investment period. “The uncertainty about the long-term impact of the change in the balance of monetary and fiscal policy leads to a wide range of possible macroeconomic and market outcomes over time and between countries, “they observe.
Ultimately, what is in question is how sustainable is the new paradigm that seems to be imposing itself in the global economy, in which the traditional concerns about deficits and indebtedness seem to have taken a back seat. As Gonzalo Lardiés, manager of Andbank, observes, the turn in front of the theories defended until just a few quarters ago: “If this had been applied earlier, we would have saved a few crises in the last 20 years,” he says.
But, precisely, he considers that if then there were objections to an answer in this sense, it was due to the doubts that a system necessarily generates in which the central banks have placed on their shoulders the task of guaranteeing financing conditions acceptable to an economy increasingly in debt. “To what extent is all this sustainable?“, questions Lardiés, who considers that the economy and markets move today with a balance” with a very weak foundation, which can crack at any moment. “
How these risks will evolve depends on very diverse and uncontrollable factors, the most obvious of which is today the coronavirus pandemic. The market seems increasingly convinced that after this a new era awaits, built on the story of fiscal stimuli and that will allow us to turn the page on the anomalies experienced in recent years. However, the road to a new normality on the parquet does not seem easy. Maybe, because hethe normality of the market was never easy.