Fiscal policy to dominate in the 2020s
Evan Brown, Head of Multi-asset Strategy told investors that investing in the new decade "should be quite different" to the 2010s.
Central bankers are worried they don't have enough space to ease. It'll have to come from fiscal policy.
No recession in 2020
Our view is that we will not see a global recession in 2020. But whenever the next recession does arrive in the coming decade, neither the US Federal Reserve (the Fed) nor other major central banks appear to have sufficient room to ease policy rates enough to reinvigorate growth and inflation.
In previous cycles going back to the 1950s, the Fed's response to a collapse in demand has been to cut the Federal Funds rate by an average of 550 basis points.
At the time of writing, the Fed has room for only another 175 basis points of cuts, having publicly stated its opposition to moving below the zero lower bound and into negative interest rates.
Fed has cut 550 bp on average in recessions historically
In the Eurozone, Japan and Switzerland, policy rates are already negative, giving respective central banks next to no ammunition in the next downturn via the policy rates channel. Quantitative Easing (QE) could be increased again, but like official policy rates, the impact of QE on the real economy and on asset prices has diminished over time. This leaves major central bankers with a limited and increasingly ineffective toolkit with which to address the next recession.
From monetary to fiscal policy
So when the next downturn does come, we do not believe that monetary policy in isolation will be able to perform its usual counter cyclical role.
Instead, we see the burden of providing the major stimulus to demand and inflation landing on government spending. Elected officials will therefore face a stark choice: let the economy stagnate, or spend. Given the very obvious electoral benefit incentive, we don't believe that many senior politicians will deliberate very long before embracing the fiscal mantra.
Economic arguments for fiscal policy playing bigger role
But there is more to the fiscal story than political expediency. In our view, the social and economic arguments for fiscal policy playing a significantly greater role in the overall policy mix in the 2020s are strong. We believe that current low borrowing costs provide further momentum. Indeed, with the cost of borrowing below current growth rates in major economies, it is theoretically possible for governments to borrow to fund fiscal stimulus and to address social imbalances without increasing overall net budget deficits. We also sympathize with the view that any fiscal multiplier (the benefit to the economy for every USD of government spending) may be greatest precisely at the point where monetary policy stimulus is at its least effective. If we are not already at that point, we do not believe that it is very far away.
If the arguments appear compelling, there are still hurdles to overcome. The blurring of the lines between elected officials and central bankers is far from straightforward and, at first glance, appears unlikely to evolve swiftly. We would highlight Germany in particular as a country with the scope for a significant fiscal stimulus to boost growth, but with little apparent political will currently to counter the balanced budget requirement enshrined in German law to progress such a move.
But the political backdrop can also change quickly. The pressure on governments including the UK, Germany, Japan and elsewhere to borrow and spend more is increasing - witness the promises of the major parties ahead of the UK general election. The finer details of a significant fiscal package are expected in the coming months in Japan where the government is already seeking to spend its way to higher growth.
Our conclusion then on government spending is more general than specific in nature: even if a major increase in fiscal spending isn't necessarily imminent across all major economies, the direction of travel for the coming decade seems very clear indeed.
Why will fiscal spending push yields higher?
Hear Evan explain in the video below:
Fiscal policy doesn't happen in a vacuum.
Perspectives matter. Tune in to our insights.
More insights for investment outlook 2020