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The Trillion Dollar Question

One of the most pertinent issues of the current market cycle is the change of the traditionally understood relationship between fiscal policy and the macroeconomic dynamic. 

Macroeconomics 101 teaches that governments tend to use fiscal policies as countercyclical buffers – easing fiscal policy when the economy is slowing down and tightening fiscal policy when the economy is overheating. Monetary policy being the other tool to regulate business cycles and influence the economy to desirable conditions. 

But investors have to change their mindset going forward.  

Fiscal profligacy started way before Covid – the Trump Administration kickstarted fiscal stimulus via tax cuts in 2017/2018 just at the “wrong” time – when  unemployment was in the low single digits and the US economy was humming along fine. The Covid pandemic merely exacerbated the trend of what the research firm Gavekal calls the move from the Washington Consensus to the “Buenos Aires Consensus“. 

After aggressively pulling out fiscal levers during the pandemic, policymakers worldwide realise the power of fiscal stimulus and central bankers are starting to realise how powerless monetary policy is when it comes to solving certain kinds of issues that they unfortunately have to address. 

Once a policy of providing handouts in emergency situations (like the pandemic) is implemented, it is difficult to backtrack on it unless the receivers are disciplined and mature enough to understand the prudence of removing such policies or why such policies are one-offs. 

Authoritarian governments may get away with removing such measures by sheer force of will (at least in the short-term), but chances are way lower in electoral democracies.  

As we see disinflation trends taking place in most parts of the world, we have to think further out into 2024 and 2025 to understand the potential changes in the macroeconomic dynamic. Central banks may finally be able to start easing monetary policy once they are comfortable with the trend of inflation – but the risks of a resurgence cannot be ignored. 

Other than structural trends of supply-chain rejigging / near-shoring and , the impetus for pulling out fiscal measures once more is still on the table. Moreover, many countries in the world are facing elections in 2024: 

  • Taiwan 
  • Indonesia 
  • South Korea 
  • Mexico 
  • EU Parliament 
  • US 
  • South Africa  
  • UK 

This is an important development to keep track of, as fiscal impetus may turn positive again especially if the current slowdown starts to deteriorate in a direction that most elected politicians aren’t comfortable with. 

Hence, if the world is in the “Buenos Aires Consensus” and disinflation continues, the bigger picture view of things is that macro investors shouldn’t be too bearish on risk assets like equities and commodities, and shouldn’t get too bullish on fixed income and bet that the typical disinflation/deflation dynamic that transpired during the 80s-90s “Great Moderation” will occur once more because traditional relationship of fiscal policy and budget discipline is no longer being held. 

This also means that holding long fixed income isn’t the dominant trade any longer. 

One of the most pertinent issues of the current market cycle is the change of the traditionally understood relationship between fiscal policy and the macroeconomic dynamic. 

Macroeconomics 101 teaches that governments tend to use fiscal policies as countercyclical buffers – easing fiscal policy when the economy is slowing down and tightening fiscal policy when the economy is overheating. Monetary policy being the other tool to regulate business cycles and influence the economy to desirable conditions. 

But investors have to change their mindset going forward.  

Fiscal profligacy started way before Covid – the Trump Administration kickstarted fiscal stimulus via tax cuts in 2017/2018 just at the “wrong” time – when  unemployment was in the low single digits and the US economy was humming along fine. The Covid pandemic merely exacerbated the trend of what the research firm Gavekal calls the move from the Washington Consensus to the “Buenos Aires Consensus“. 

After aggressively pulling out fiscal levers during the pandemic, policymakers worldwide realise the power of fiscal stimulus and central bankers are starting to realise how powerless monetary policy is when it comes to solving certain kinds of issues that they unfortunately have to address. 

Once a policy of providing handouts in emergency situations (like the pandemic) is implemented, it is difficult to backtrack on it unless the receivers are disciplined and mature enough to understand the prudence of removing such policies or why such policies are one-offs. 

Authoritarian governments may get away with removing such measures by sheer force of will (at least in the short-term), but chances are way lower in electoral democracies.  

As we see disinflation trends taking place in most parts of the world, we have to think further out into 2024 and 2025 to understand the potential changes in the macroeconomic dynamic. Central banks may finally be able to start easing monetary policy once they are comfortable with the trend of inflation – but the risks of a resurgence cannot be ignored. 

Other than structural trends of supply-chain rejigging / near-shoring and , the impetus for pulling out fiscal measures once more is still on the table. Moreover, many countries in the world are facing elections in 2024: 

  • Taiwan 
  • Indonesia 
  • South Korea 
  • Mexico 
  • EU Parliament 
  • US 
  • South Africa  
  • UK 

This is an important development to keep track of, as fiscal impetus may turn positive again especially if the current slowdown starts to deteriorate in a direction that most elected politicians aren’t comfortable with. 

Hence, if the world is in the “Buenos Aires Consensus” and disinflation continues, the bigger picture view of things is that macro investors shouldn’t be too bearish on risk assets like equities and commodities, and shouldn’t get too bullish on fixed income and bet that the typical disinflation/deflation dynamic that transpired during the 80s-90s “Great Moderation” will occur once more because traditional relationship of fiscal policy and budget discipline is no longer being held. 

This also means that holding long fixed income isn’t the dominant trade any longer.