The new era of big governments, during which governments will take a more direct and proactive role in economic policy and management through fiscal policy, has begun to emerge and is expected to stay for decades to come, according to Insight Investment.
This new ‘neofiscalism’ would mean that the neo-liberal paradigm, with smaller government involvement in the economy, might be under threat and it would remain in stark contrast to the current regime under which central banks were largely making monetary policy decisions without political interference, the manager said.
According to Insight’s global macro research team, this would have five key implications for markets:
1. Bond markets may become Japanese-like for a long period and relatively low volatility by historical standards could lead to a grab for yield that compresses spreads and flattens yield curves;
2. Inflation could trigger spikes in bond yields if it causes quantitative easing to be tapered and such opportunities would likely be attractive entry points, as long as the longer-term expectation was for inflation to return to target following the funding squeeze in the real economy;
3. For sovereigns without full control over the currency they issued in, government effectiveness could be key and effective governments that were able to raise productivity and trend growth could more swiftly reduce debt/GDP ratios;
4. Governments able to maximise trend growth would likely become important for equity markets as this would become a key driver of earnings; and
5. Corporates with state support could have an advantage during funding droughts.
“The COVID-19 crisis has pushed fiscal and monetary policy to extraordinary levels. While Australia’s debt to GDP levels have historically been far lower than many developed economies, we expect the prolonged lockdown in Victoria will see fiscal deficits materially widen on par with the UK, and our debt to GDP ratio to increase significantly,” Bruce Murphy, director of Insight Australia and New Zealand, said.
“We believe higher deficits are here to stay and governments will be forced to maintain fiscal deficits at these levels for a prolonged period of time.”