Policy revolution

The policy revolution was needed to cushion the devastating and deflationary impact of the virus shock. In the medium term, however, the blurring of monetary and fiscal policy could bring about upside inflation risks.

Filling in the gap
Estimated virus hit to GDP vs. offsetting policy measures, 2020

View our Midyear Outlook in charts

• There has been a much-needed policy revolution to cushion the coronavirus shock. Policymakers are relying less on financial sector transmission to stimulate activity –and more on direct support to the real economy. There is a blurring of fiscal and monetary policies as well as government intervention in the economy and financial markets.
• The global policy response to the pandemic has been unprecedented in speed and size. The combined sum of fiscal and monetary actions is covering the virus hit to the economy in both the U.S. and euro area. See the Filling the gap chart.
• We now see a risk of policy fatigue in the U.S. as policymakers face a series of “fiscal cliffs” and may cut fiscal relief prematurely – one reason for our U.S. equities downgrade. By contrast, Europe has ramped up stimulus efforts. This partly underpins our upgrade of European stocks to overweight.
• We wrote last August about the necessity for effective monetary and fiscal coordination in a major shock because it would reduce lost output and could lessen risks such as rising inequality. Without proper guardrails and a clear exit strategy, however, we warned of a medium-term risk of uncontrolled deficits with commensurate monetary expansion and, ultimately, rising inflation.

Bottom line: The policy revolution was essential. It is a near-term positive for risk assets – but is unlikely to be the prelude to the type of policy-driven, decade-long bull market that followed the global financial crisis.

Strategic implication: We are underweight nominal government bonds and like inflation-linked bonds.

Tactical implication: We like credit, partly on central bank purchases. U.S. stocks are at risk of fading fiscal stimulus.