A (mostly) dismal view
The theme, as I’m sure you have heard, was “Risks to the Outlook” and I thought that the conclusions from the conference would provide a great foundation for the blogs of 2019. As you might have understood from the title of this blog, the discussions – though highly interesting – did little to lift my spirits.
The main economic outlooks
Being a first-time moderator, I had of course over-prepared with sheets of questions and a meticulous structure to our conversations. For example, one thing I really sense lacking when you meet analysts for the first time is a “table of contents”. Which is why I had hoped to get a swift feel for how dismal these scientists’ views really were, by asking them about their view on developments post-crisis. In particular, how did they explain the post-crisis shifts and changes in income trends visible throughout most of the world economies?
Whereas all panelists in the first panel (Economics) agreed that developments since the time around the financial crisis had been marred by a structural slowdown, predominantly due to demographics, there were, in reality, rather large discrepancies between the panelists. Half of them felt that there are plenty of unused resources and that central banks (looking at you ECB!) are far too pessimistic on the possibility of increasing labor force participation anew. Hence, cost pressures – wages – were thought to remain subdued, which was actually a common view across the participants. Then again, albeit not expecting recession, and for different reasons, all the panelists foresaw a deceleration of demand in their main scenario, possibly explaining the analogous conclusions from quite different starting points. Somewhat to my surprise, the short-term views on Europe were quite optimistic, with fiscal stimuli and improved real household incomes making up the main foundations.
That didn’t stop anyone from expecting a soft spot in the later parts of 2019 and during most of 2018 with possibly chaotic developments due to already strained public finances in many Euro Area economies.
What about the US, you may wonder…? Well, there was complete agreement on the US outlook with some deceleration as the fiscal stimuli fizzles out but no apparent risk of recession as the FED was hailed for its proactive stance.
Looking at risks – what we don’t know
As the panel continued its discussions, I tried to move the focus more towards risks and we structured this part according to “my version” of the Rumsfeld Risk Matrix:
The known knowns were more or less covered in the initial discussions and apart from being limited to policy mistakes I managed, admittedly not without some degree of coercion, to get everybody to agree that the nascent signs of wage inflation – should it continue to increase – was something that would be regarded a fatal blow to the assumptions and forecasts on display at the conference.
We also managed to cover some of the Knightian risks, the known unknowns and unknown unknowns. However, since I suggest it is near impossible to discuss the unknown unknowns (Genuine/Knightian uncertainty) we focused on known unknowns – gaps in the understanding of risks and here – for the first time – I noticed a spark in the corner of the eyes of my dismal brothers (and sister) in arms. The creativity when discussing the horrors we could face knew no limits, though my idea had been to focus on the Italian situation [Usc-Ita!] and the impending Brexit. Perhaps even some ideas for better outcomes than expected. On that note, nonetheless, the panel turned completely silent and stared at me as if I had betrayed the very meaning of being economist.
Now, to mention a few of the risks: Technological unemployment; Populism destroying the liberal world order; Trade-war turning into actual war, epidemics, and; event-horizons and non-linearities in climate changes. – Yes, it was a real fun-filled session.
Of the more tangible risks I think there were a few things I can underline: The views on Italian politics were rather sanguine and there seemed to be agreement on political risks – Usc-Ita – being (at least temporarily) neutralized after a few failed government attempts to tilt against the European institutional windmills. That said, the unstable political situation and structurally detrimental policies had already wreaked havoc on business sentiment and a dramatically deteriorating cyclical situation was almost invariably seen as leading Italy into a debt crisis.
Our discussion on Brexit was unfortunately cut short by intertemporal disagreements (that’s Swedish for a bad moderator unable to steer discussions within time limits) but as economists we are quite simply befuddled by politics. Relaying also some pre-panel discussions I think we can sum it up accordingly: The risk for a hard (no-deal) Brexit has clearly increased over the past few weeks and apparently some believe this could be a way for PM Theresa May to strongarm a divided parliament and conservative party into accepting the same deal the government negotiated and that was turned down in a previous vote. And even if it is yet again turned down, May could ask for an extension and then, well, who knows. However, and under any circumstances, few seem to believe that the pro-EU wings of Labor and the Conservatives will be able to push for a second referendum. Possibly, if Brexit spells a complete economic disaster for Britain, hopes are that a rapprochement will be possible “in a few years”. On a personal note, and even after three years of discussing Brexit in all possible situations, I must admit that the whole thing is still unfathomable. When will we wake up from this Kafka-like nightmare?
In the second panel I had completely thrown away any hopes of containing the discussions and just ran with it – hard to say if it was an improvement or not, to be honest. What did, nonetheless, improve was the modus operandi of the panelists: “Volatility – for a lack of a better word – is good. Volatility is right. Volatility works.”. While the economic canvas our market pundits painted their financial outlook on took a cue from the previous session, with slowdown but no recessions in play for 2019, there were still a couple of issues that caught my attention: (1) Despite having one of the financial markets’ most preeminent experts on financial flows on our panel and other prominent pundits representing both equity and fixed income markets, the recent admonishment from the FED to soon hold “quantitative tightening” (QT) was not seen as the fix-it-all for financial markets that I thought.
“Not all QT is created equal” was a catch-phrase that came up a few times. What this meant, when pressing the panelists further, was that the main risks from QT were believed to come from an increased supply of government bonds. These bonds, once purchased from L&Ps and other AMs, was believed to have been the main culprit to flows into other asset classes and emerging markets; the whole “search for yield” discussion. The purchases of other assets (MBS, corp bonds etc.) was rather considered a tool to relieve more acute stress in the domestic banking systems during the height of the global financial crisis and Euro Area crisis.
Now, I’m no expert, but pushing this line of thought further should mean that if a total drawdown in the FED’s system open market account (SOMA) treasury-holdings of around USD 250 bn was enough to cause the ruptures seen in financial markets during December last year, I am wondering what will happen in the coming months as the FED still has some USD 750 bn left to dispose of before year-end 2019 (which currently seems to be when the FED sees an end to the balance sheet reductions). Also, note to self, the FED currently has around USD 2.2 trn in treasuries and the ECB holds some EUR 2.1 trn in their government bond (PSPP – public sector purchase program) coffers. Of course, the latter, together with some other heavy-hitting central banks, has not even begun an outright reduction of the balance sheet yet.
Taking the above into consideration, I must admit to being somewhat taken aback by the insistence of the majority of the panel in recommending allocating money into both equities and emerging markets. That said, this seems to be the wisdom of the crowds as well and has – admittedly – been a roaring success in the early days of 2019. And maybe that’s the real beauty of having a few extraordinarily savvy market pundits as our friends, they help us see through risks and identify opportunities instead – you just have to be fleet-footed enough to manage the ebbs and flows of international capital flows.
On another note, I think it is important to underline that this group of market analysts also found I was dimwitted to ponder higher inflation and (at least nominal) interest rates in the near-term. “Can’t see that happening” was the immediate take-away on my feeble attempt to thin outside the box. – I won’t bring that subject to the table again anytime soon, I can assure you… 😉
I’d like to finish today’s post by saying a last word about the conference: it was quite an experience for all of us and I feel immense gratitude to all colleagues that more than made up for my own organizational shortcomings. In particular, our own can-handle-anything-we-throw-at-her-ist, Dirkje Viljoen. And, of course, thanks to all who participated in our conversations – attendees as well as panelists. – Thank you all!
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