At the start of 2020, the global economy entered unmapped territory as the COVID-19 pandemic took hold. For Nick Chamie, IMCO’s Chief Strategist, the manner in which governments around the world responded to the pandemic could reshape market dynamics in the future.
What makes the COVID-19 crisis different from other economic shocks in recent decades?
It really helps to take a historical view here, because to experience the impact we’re seeing today, you’d have to go back to the Second World War. In fact, all the way until the 1960s, economic cycles were highly volatile. It was around then that governments really started employing economic theory, along with various policy levers, to smooth out business cycles.
It worked well – there was a tremendous amount of success in terms of creating more stable economic growth and better economic outcomes. Then, in the 1980s, we witnessed U.S. Fed Chairman Paul Volcker wage war on inflation, which ultimately led to steady declines in interest rates.
Fast forward to the Great Financial Crisis, and rates fell to zero, and even into negative territory in Japan and Europe. It became clear there was relatively little room left for monetary stimulus in the traditional sense.
All of this left us heading into the pandemic on really weak footing, monetary-policy wise. Policy makers realized that given the depth of the coming recession, fiscal policy would have to do the heavy lifting instead. The strength of that response is creating massive deficits, and it appears increasingly that there’s appetite to see that continue into the future, given the current low-growth and low-inflation environment. And with rates as low as they are, it’s more appealing to borrow and also easier to service.
So the discipline you described earlier is being relaxed because of the pandemic?
Exactly – that’s really where the seismic shift is occurring. We are seeing governments move away from the traditional approach of previous decades, where policy makers tried to maintain fiscal discipline and cap how much they borrowed. That has in many ways disappeared because of COVID-19 and there’s a renewed desire for ongoing fiscal support of the economy.
It’s still unclear whether this will create new market dynamics that haven’t been seen in the past, but it’s certainly possible. For example, we could see a stronger response in more cyclical assets, in what’s called an “inflation trade.” That would include commodity prices – particularly gold – rising over time and commodity currencies like the Canadian dollar outperforming. We’re watching and planning for all of these potential scenarios closely.
We’ve heard a lot about the disconnect between the markets, which have stayed buoyant, and the economy, which has been significantly hurt by COVID-19. What’s your view of this phenomenon?
I think it’s very normal to see markets disconnected from the broader economy, especially in early parts of the recovery. Markets are trying to anticipate the future, while the economy is still bottoming out and trying to find its footing.
However, this time around feels a bit different and the disconnect appears larger. There are some dramatic changes occurring with respect to the money supply, which is expanding rapidly. And again, rates have remained low.
When you combine these factors, it could make sense that financial assets are increasing in value even faster than before, because the supply of U.S. dollars is growing dramatically faster than assets being priced in U.S. dollars.
We’re also seeing a building wave of support for deglobalization.
Absolutely. History tells us that during difficult times, leaders and nations can turn inward and prioritize domestic concerns over global ones. Income inequality is also accelerating. As a result, we’re seeing a jump in nationalism and populism, which led to trade protectionism.
I believe we will see an inward-looking phase over the next 10 years. However, there will eventually be a renewed commitment to globalization, which really has become a permanent fixture of modern economic life. We might see some modest changes at the margin, but I expect that the globalization gains that we’ve seen over the past 60 years or so will largely remain intact. An important implication of these forces is their interplay with rising US-China tensions which could lead to wider shifts in global supply chains.
You’re also keeping a close eye on Asia as this economic cycle unfolds – what’s driving your interest?
Asia is without a doubt one of the most compelling parts of the world right now. It continues to have a tremendous amount of potential growth, in addition to being the first in and the first out of the COVID crisis. They’re in a unique position where their recovery is helping the rest of the world recover as well because the lessons are first being learned in Asia.
China, for example, showed some restraint in its response, and it’s really encouraging to see them bounce back without spending their way to recovery. Japan, too, has managed reasonably well, as have many other countries in the region, so I think investors should pay close attention to Asia going forward.
What else should investors be keeping in mind as we wrap up the year and head into 2021?
First, COVID-19 isn’t going away and will continue to weigh on global growth. So that will remain a persistent theme, especially in terms of governments and companies finding treatments and vaccines that allow for a lasting return to more stable economic activity.
Second, the U.S. Presidential elections will be a very important market event that the rest of the world will be watching closely, particularly given that the U.S. economy is so closely interlocked with others around the world.
And third, and somewhat related, is the evolution of the U.S. dollar, given its extremely widespread impact on asset valuations and markets around the world. My view is that we are likely entering period of sustained dollar weakness in the coming years.