Whether the V-shaped recovery can last is an important question for markets. It is interesting that not even everyone agrees we are in a V-shape, even though the economic numbers show that we are.
My own view is that there has been such enormous fiscal stimulus - it added about 4% to global growth in the second quarter - that I doubt we will see such a strong boost in subsequent quarters. As we move into 2021, on current trajectories that shifts to a minus of about 1% or 2%1 so a continuation of the V-shaped recovery is unlikely without another round of stimulus. Substantial additional fiscal impetus, at this stage, would most likely be precipitated by a Democrat clean sweep in the US elections.
For now, we are more likely to see a pick-up in job losses, particularly if the second wave in COVID-19 cases and hospitalisations causes fresh lockdowns, as seems to be the case. What I would expect then is for the trajectory of global growth to slow, but it should still be positive, particularly as some areas of the world such as China are managing to defy the gloom.
It is worth keeping an eye on consumer confidence, which is ultimately driven by expectations around the income a consumer can earn. This is a critical factor in keeping the economy progressing. Stimulus packages such as the furlough schemes helped to replace lost income, but as some of that fades, we need to find a second cure, so to speak, for replacing lost income.
To some extent that may come in the form of a vaccine. If a vaccine does come, say around the new year, that would have a meaningful impact on people's expectations of income in 2021. And that is really what drives confidence.
In terms of what authorities can do to shore up the recovery, I do not think monetary policy is exhausted, but it is facing the law of diminishing returns. Central banks can always do yield curve control, or more quantitative easing, but that may exacerbate as many problems as it solves. A little bit of fiscal stimulus now will do as much as a lot of monetary stimulus and so the balance has to shift if we are going to see sustainable growth.
The US Federal Reserve (Fed) recently adopted average inflation targeting, which implied that if inflation overshoots their 2% target, they may hold steady and not overreact because they want to see that number realised over time. This change is more than just cosmetic. The pandemic induced a sharp fall-off in inflation but it is now bouncing back and could potentially overshoot the 2% target. I think by removing any risk of a repeat of the ‘taper tantrum'2 or any expectation that the Fed would react to an overshoot, they have probably quelled volatility in the markets, which is good for risk assets.
What does this all mean for fixed income? There has been a phenomenal rally in risky assets, including credit. But what you have really seen is the removal of volatility. Central banks might not be able to inject much more growth into an economy, but they can depress volatility. And they can keep doing that. What that means is that rates are not moving around very much and are likely to stay low. The suppression of volatility is synonymous with tighter credit spreads, so I think that could be the ongoing story of 2021 even if growth moderates.
1Source: JPMorgan, Global Economic Research, global fiscal thrust estimates for 2020 +3.6% and 2021 -1.7%, as at September 2020. Fiscal thrust is the percentage point amount added to or subtracted from gross domestic product by changes in government expenditure and taxation.
2 Markets' adverse reaction following the US Federal Reserve Chairman's comments in May 2013, which suggested that the US was considering tapering (slowing down) the rate of its bond buying programme (quantitative easing).
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