Bond Bites Three emerging trends in a changing world

Jonathan Gregory highlights the importance of having a long term mindset and identifies three key secular trends affecting global bond markets.

23 Jul 2020

For global investors today an occupational hazard is to sometimes feel overwhelmed by a continual blizzard of daily data. At times we all struggle to get footholds in what is really meaningful. And daily distractions breed one of the most damaging mind-sets for long term wealth creation; a focus only on the very short term.

While the day-to-day hi-frequency noise can be all-consuming, my colleagues and I believe that it is the secular trends in politics, markets and economies that really matter to bond returns over time; the fall of the Berlin Wall and subsequent collapse of the Soviet Union; 9/11 and its aftermath; the integration of China into the global supply chain, the Global Financial Crisis and the subsequent reshaping of monetary policy. It is these events, and a handful of others, that have had the most profound impact on the global economy, and hence asset returns, over the past 30 years.

If we spend a few moments to tack away from the daily noise of market chatter, what might be the secular themes today that really matter; and what might they mean for investors? In our view, at least three movements bear close attention.

1. The end of fiscal austerity

Since the Great Financial Crisis, the prevailing political orthodoxy in many developed markets was one of fiscal rectitude; less debt and more balanced budgets. But in the aftermath of COVID-19 those policies have been consigned to history – and how. With USD 11 trillion and counting of government support so far, the International Monetary Fund (IMF) forecasts G20 debt/GDP levels to soon average around 120%, the highest levels in a generation, with budget deficits at 10% of GDP or higher.

In fact, a meaningful shift in attitude towards higher fiscal spending in many countries was already underway before the global pandemic. With many economies stuck in a protracted phase of negligible real growth and falling productivity, the political pressure for more aggressive fiscal action was growing. The massive spending unleashed in response to COVID-19 means that political Rubicon has now been crossed. We should expect higher government spending, larger social programs and more politically driven allocation of capital than we have been used to in the past 10 years. This will be a profound change.

Gross debt (% of GDP) – advanced G20 economies

Advanced G20 economies gross debt as a % of GDP actual and forecast figures for 2018 to 2021

Change in Global Government debt and overall fiscal balance

Change in Global Government debt and fiscal balances as a % of GDP, Global Financial Crisis versus COVID-19 periods

2. The fading multilateral dream?

The fall of the Berlin Wall in 1989 and subsequent collapse of the Soviet Union fed widespread optimism that formerly communist countries would complete a rapid transformation into open market liberal democracies; and at the same time existing parliamentary democracies would embrace more open borders and closer integration. To an extent these dreams were fulfilled, certainly in Europe, where several formerly communist countries were integrated in whole or part into the European Union. At roughly the same time the rapid integration of China and other emerging market countries into the global supply chain drove a period of market-led globalization. It brought the world closer to a frontier-free single market than perhaps it had been for 100 years.

Whether or not the benefits of these developments were shared equally is open to debate, but for the owners of capital they certainly helped drive a lengthy period of strong asset price returns. It is evident though that over the past few years many of these trends have stalled, if not gone into outright reverse. The shift away from centrist politics in developed markets, a serious counter-revolution against a multilateral world order and a rise of more authoritarian regimes certainly seem to herald a rather different secular outlook from the one we have become quite used to.

3. The fight against social injustice

For all the attention lavished on the pandemic and its aftermath, by far the most enduring legacy of 2020 could be the brutal exposure of the daily reality of racial and social injustice for far too many people in the world today. Government, institutional and corporate diversity has been brought into critical and uncompromising focus. The challenge here is already well understood but today the determination to address the issues once-and-for-all is palpable; ignoring them is simply not feasible. And the demands for reform reverberate across governments, corporates, institutions, consumers and voters – in many countries sectors of the economy are ever more united in driving real and lasting change.

What might this all mean?

Well to begin with, destroying embedded inequality and social injustice in societies will be an unmitigated good for the global economy. In fact, those countries that can make real and lasting changes could enjoy meaningful improvements in labor force participation and most likely higher productivity and growth. If there is one reason to be optimistic about the future, this is it.

The impact of the dramatic fiscal expansion is more ambiguous. Yes it certainly has the potential to lift aggregate demand and therefore reduce output gaps in economies operating below capacity. But the upside risks for inflation will be greater than at any point in the past 10 years (fiscal austerity was probably a structural factor in keeping inflation low). And this is certainly the case for some policy proposals that advocate an even more dramatic fiscal expansion, central bank caps on bond yields and moving responsibility for managing inflation from the central bank to the government1.

The impact of the challenge to the multilateral world order may also be double-edged but, at face-value, does imply less free movement of goods, capital and labor than we have become used to. In turn this could hurt global growth and pose upside risks for inflation.

We have highlighted just three secular themes out of several we believe will be instrumental in shaping real investment returns in the years ahead. We will explore in more detail the paths that some of them may take in future commentaries. In our experience it has often paid handsomely to spend time to identify these themes, reflect on how they will reshape the global economy and act accordingly. Too much focus on the short term can be seriously damaging to returns. For more information on how our current thinking shapes our Global portfolio construction please click here.