Turning on the spending taps
One of the key issues for financial markets in 2020 will be whether stimulative fiscal policy replaces easier monetary policy. In countries such as China, Japan and the UK governments are under strong pressure from electorates to turn on the fiscal taps.
As a new decade dawns, commentators are queuing up to proffer their opinions on the prospects for financial markets. Typically, they will (in the words of the old Johnny Mercer song) accentuate the positive: supportive central banks, a buoyant consumer on the back of solid jobs growth, and helpful investor positioning.
At the same time, it would be remiss to eliminate the negative. Because there certainly are political risks ahead – notably the US Presidential election, US-China trade rivalry, a heightening of tensions in the Middle East, and uncertain prospects for UK-European Union (EU) talks.
All these factors will have a major impact on the direction of financial markets in the coming months. However, many commentators are missing an important – if slow-moving – issue that is sure to exert a major influence. During the 2010s, in the aftermath of the financial crisis, extraordinary economic conditions called for extraordinary economic policies – in the shape of quantitative easing and ultra-low interest rates. But now, many believe the prospects for the world economy depend on a successful transfer from monetary to fiscal policy – tax cuts and spending increases, especially on important areas such as infrastructure. Central bank governors, such as Mario Draghi and Christine Lagarde at the European Central Bank and Jay Powell at the US Federal Reserve, have warned for some time that monetary policy is becoming less successful in its current guise.
Is fiscal stimulus effective?
Where are we seeing fiscal policy having an effect? One good example is France. Since the peak of economic activity in 2017, French GDP growth has slowed – but by about half the rate experienced in Germany. One factor has been the relative importance of the manufacturing sector in both countries. Another was France’s fiscal response to the ‘yellow vests’ protests; tax cuts have supported consumer spending, meaning its fiscal deficit is one of the higher across the EU nations.
Looking ahead, the UK and Japan look to be on the verge of easier fiscal policies. In Japan, a combination of the consumer tax rise in October and the ongoing trade conflict between the US and China has hurt domestic manufacturing. The government has responded with an economic support package. Understandably, Shinzo Abe wants to leave a legacy before his tenure as prime minister ends in 2021. He wants to show he has halted deflation and returned Japan to steady economic growth.
Details of Japanese stimulus programmes are always rather vague. However, indications are that headline numbers include up to Y13tn over 15 months focused on disaster relief, strengthening infrastructure, and maintaining growth after the 2020 Tokyo Olympics. Whether this will be sufficient to sustain economic growth of about 1% in both 2019 and 2020 is the major area of debate. Our concern is that the headline looks more impressive than the details.
In the UK, the election result has also encouraged the Conservative government to switch on the fiscal taps.
In the UK, the election result has also encouraged the Conservative government to switch on the fiscal taps. Winning so many seats previously held by the Labour Party has given Prime Minister Johnson a large majority. However, he is keenly aware that such votes were ‘lent’ to him and could disappear if living standards do not improve noticeably over the next five years. Hence, headlines that £100bn will be spent on infrastructure, mainly in the north and midlands of England. The Office for Budget Responsibility doubled its estimate of how much the government is likely to borrow over the next five years, even before taking account of pre-election spending promises or a weakening economy. The Budget on 11 March should be watched with considerable interest!
Facing a dilemma
The pressures to spend such sums wisely can be aptly summarised by the dilemma facing the UK. On the one hand, tax cuts and an end to austerity may be politically popular. However, taking longer-term action to improve economic growth via infrastructure spending takes time. This has been amply demonstrated by the sagas over a further runway at Heathrow or the high speed rail line from London to the north of England. There is significant doubt that voters will see any benefits quickly.
Europe may be the swing factor in this broader debate. An example will be the success of newly appointed ECB President Christine Lagarde in forcing opinions to change among the fiscal hawks in different countries. Already, the fiscal stimulus across Europe is set to become modestly positive for the first time in a decade.
How will global investors view all these developments? Although monetary stimulus has stabilised the world economy, one must consider whether fiscal stimulus can take up the baton and provide a further impetus to business activity. Prospects for profits growth in 2020 are muted. Headline announcements can encourage investors to reassess the situation, especially if a market is unloved – as has been the case in the UK. However, the devil will be in the detail. Does a fiscal stimulus have a noticeable effect on economic activity, boosting domestic activities such as consumer spending, house building and capital spending? Or does a programme of infrastructure spending remove any of the logjams which are noticeably holding back an economy? The risk otherwise is that investors turn their attention to ever-higher fiscal deficits and whether high debt levels will encourage a further shift towards ‘Japanification’.