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Having long been supported by ample liquidity, financial markets are entering the final quarter of 2020 amid an increasingly tentative global economic recovery, unusual political uncertainties, and lagging fiscal and structural policy responses. And these headwinds add to the COVID-19 crisis, which has left most countries struggling to strike a balance between protecting public health, achieving a return to a semi-normal level of economic activity, and limiting violations of individual liberties.
In this context, the hope is that today’s generous liquidity conditions, enabled and supported by central banks, will continue to provide a bridge to a better 2021, not only reversing the economic and social damage, but also bringing more returns to investors. . But will this bridging operation, already deployed over several years, be enough to offset other headwinds, to overcome what is an increasingly complex pandemic cocktail?
Recent economic data indicates that, outside of China and some other countries, the economic recovery remains uneven and uncertain, and falls short of what is necessary and possible, in my opinion. Travel, hospitality and other service sector activities continue to face considerable challenges, complicating the overall employment outlook. In addition, a growing number of companies in other sectors are pursuing “downsizing” initiatives that are likely to lead to fewer hiring or even a wave of layoffs.
These economic challenges are compounded by deepening political uncertainties, especially in the United States. An already highly uncertain electoral process has been further complicated by President Donald Trump’s COVID-19 infection. And now that several lawmakers have also contracted the virus, congressional deliberations on many vital issues have been delayed. The United States Senate has been left with little time to consider anything other than the nomination of a new Supreme Court justice, which the Republican majority insists on pushing before the end of Trump’s term. As a result, there is little hope for a new fiscal relief package, growth-friendly structural reforms, or any other significant policy initiative from the United States in the coming weeks.
Meanwhile, America’s participation in multilateral policy deliberations, not to mention America’s global leadership role in general, remains restricted. To further complicate matters, economic and financial responses elsewhere are also reaching a ceiling, particularly in the developing world, where governments are running out of political space due to high deficits, rising debt and a more unstable monetary dynamics. This uncertainty in policymaking is magnified by the broader struggle to achieve the three main goals of the pandemic era: maintaining public health and protecting citizens; avoid further damage to the social fabric, economic well-being and financial viability; and minimize restrictions, also in the interest of avoiding “pandemic fatigue”.
Despite this cocktail of uncertain, unsettling and inherently volatile background conditions, stocks and other risky assets have shown remarkable resilience. In particular, a sizeable portion of investors have been willing to continue to “buy the downturn”, either because they believe there is “no alternative” to equities, or because the market’s reliable bounces in recent years have stoked their “fear. to be lost. “This BTD-TINA-FOMO conditioning, to use the language of the market, is based on two factors.
First and foremost, investors rely heavily on the willingness of the systemically important central banks, that is, the US Federal Reserve and the European Central Bank, to inject liquidity at the first sign of a break. serious stress on the market, regardless of how much further they have advanced. venture into the domain of unconventional experimental politics. However, by creating an ever-widening gap between market valuations and economic fundamentals, central banks may be jeopardizing their own credibility, amplifying wealth inequalities, and increasing risk to future financial stability.
Second, investors tend to view most, if not all, current market challenges as not only temporary but reversible as well. The assumption is that the uncertainties of the US elections will be resolved quickly; fiscal and structural reform efforts will be restarted, making up for lost time; and progress toward new COVID-19 treatments, vaccines or herd immunity will continue to accelerate. Meanwhile, markets have come to “expect the unexpected.”
I am not in a position to predict the outcome of the elections or the prospects for improvements in public health conditions. But I have some confidence in identifying possible economic scenarios and their consequences, and in this matter, timing is important. Whether a comprehensive policy response is adopted now or in a few months has a direct bearing on its potential impact.
After all, for every day that lawmakers delay, there will be even fewer hires, more layoffs, and an increased risk of corporate bankruptcy, especially among the growing number of companies whose financial resilience is eroding as they face tighter credit conditions and your cash burn continues. . Consequently, the longer the delay, the greater the issues any future package will have to address and the more difficult it will be to design and implement.
In recent years, investors have tended to be rewarded for neglecting traditional determinants of market value and focusing on just one thing: abundant and predictable injections of liquidity into the market. But the next few months will likely be a bigger test for this bet. Wall Street has decoupled from Main Street in a way few expected. It would be a mistake to keep extrapolating into the future without stopping to ask about the increasing collateral damage and unintended consequences.
Editor’s note: Mohamed A. El-Erian, Allianz chief economic adviser and president of Queens’ College at the University of Cambridge, was president of the Global Development Council of US President Barack Obama. He is the author, most recently, of The only game in town: central banks, instability and avoiding the next collapse. The article is provided to The Reporter by Project Syndicate – the world’s leading source for original opinion comments. Project Syndicate provided inclusive perspectives on our changing world from those who are shaping politics, economics, science, and culture. The opinions expressed in this article do not necessarily reflect the opinions of The Reporter.
Contributed by Mohamed A. El-Erian
