Central banks’ liquidity will remain supportive for the foreseeable future. Therefore, fiscal policy will be the key policy variable going forward. Accordingly, the number-one risk in markets today is a premature withdrawal of fiscal stimulus rather than excessive public debt.
The easy phase of the economic recovery that followed the shutdown is already over. From now on, the recovery of gross domestic product (GDP) losses will be more laborious and, above all, more heterogeneous. In view of the resurgence of Covid-19 cases in some regions, which again gives rise to prudent behaviour or even quarantine measures, it will take longer to close the output gap and get back to the end-2019 GDP levels of activity in leading economies, with the exception of China. Of course, the vagaries of the coronavirus complicate the picture, as the possibility of a drug or vaccine could change the outlook overnight.
Given the current economic backdrop, central banks are expected to remain in accommodative mode for several years to come. The main risk for economies therefore lies in the premature withdrawal of fiscal stimulus. Unlike monetary policy, which remains accommodative until it is actively changed by central banks, fiscal stimulus needs to be renewed periodically until the private sector can ensure sufficient growth. In light of the pandemic situation, governments will have to reconduct measures to further support households and private corporations. A reduction of public-sector demand would trigger a renewed contraction of the economy.
Critically, fiscal support measures need to be renewed periodically, in contrast to monetary support, until the private sector is able to ensure sufficient demand; otherwise the economy could stall.
US presidential elections is the key upcoming event
The US presidential election, scheduled for 3 November, is the main political uncertainty until year end. The stark contrast between the political programmes advocated by the Republicans and the Democrats is remarkable. Democratic contender Joe Biden has led in the polls for the past few months, but his lead has narrowed recently. Incumbent President Donald Trump, a Republican, will do whatever it takes to win this election. Whatever the outcome, it could be contested for several weeks, particularly if there is a narrow victory, and lead to serious protests across the country. While we expect the political frictions to calm down eventually, the outcome may have major implications for financial markets, particularly for investment styles and sectors.
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From the long-term perspective to short-term explanations of what is going on in the economy and markets – our Group Chief Investment Officer shares his views.