Limited monetary ammunition versus fiscal expansion…
Low interest rates, he argues, continue to distort decision-making, while QE’s boost to asset prices has become counter-productive. In this way, 2020 offers more of the same. Yet, differences could include a step-up in geopolitical risk that’s so far not been allowed to disrupt stock markets.
In which case, the risk to elevated markets comes not from central banks, but from political distrust and protectionism. The contradiction of wanting to address imbalances and distortions yet wanting to be alert to increasing trade tensions and voter enmity is the starting point in 2020. Although, it looks to be a convoluted wish-list that cannot please all.
Five core beliefs…
Amid these conflicting forces, our macro outlook is based on five core beliefs. First, political distrust and beggar-thy-neighbour policies will continue to build. The 1930s revealed few winners from a trade war. Retaliation could eventually include a reluctant China currency-devaluation. This, alongsideother factors, threatens a deflationary return to the US.
Second, inflation will reappear - but, it will be the ‘wrong sort’. Central banks will have to ‘turn a blind eye’ as economies stagflate. With the cost-inflation proving temporary, we may then, in the longer-term, need a sizeable mindset shift as deflationary forces (demographics etc) re-emerge.
Third, the road to ‘normal’ will remain closed off, as central banks fear their own shadows. The US Fed, as a test-case for others, has stopped QT after just two years, and is rebuilding its balance sheet! By factoring in QE, we estimate that the true US funds rate is as low as -2%, and it will not get anywhere close to its pre-2008 levels.
Fourth, governments will increasingly offer fiscal solutions to appease voters, and retrieve the ‘baton’ from central banks. Mr Trump may reflate again in his election year to reattract centrist voters; Mr Abe is taking Japan into its third decade of loosening; and the UK is ditching its deficit-ceiling. Even in the euro-zone, deficit-reduction and negative yields should make it easier to permit fiscal expansion.
Finally, in emerging markets the fundamental outlook in a more protectionist/stronger USD scenario may be less rosy. Vulnerability lies with non-commodity exporters with high exposure to short-term USD debt and foreign saving needs, such as Turkey and Argentina. But, for others, external debt-ratios are lower, with fewer currency pegs to have to protect.
In the Year of the Rat…
So, political fragility, protectionism, cost-inflation, and dissipating growth suggest renewed volatility. The dilemma for central banks may thus be between using their limited ammunition or letting fiscal expansion do the work. We will probably have to see a bit of both - rather than an inconclusive tug-of-war that threatens recession.
Otherwise, worryingly, in the ‘Lunar Year of the Rat’, 2020 would risk looking a bit like the last ‘Rat Year’: the crisis of 2008!