Jurrien Timmer on macro economy

Jurrien Timmer is Fidelity’s Director of Global Macro，here is his up-to-date interview.

Market Performance Review:

Bitcoin and Japanese equities outperformed last quarter, while bonds and commodities underperformed. Looking at the slide data, we can see that the S&P 500 and its equal-weight index have both risen by about 28% since October 2023, showing a strong recovery in the market.

The Dominance of Fiscal Policy:

The discussion noted that over the past few years, and especially since the outbreak of the pandemic, we are experiencing a shift from monetary policy to fiscal policy. This shift means that the influence of central bank policies on markets is diminishing, while government fiscal policies, including spending and taxes, have a stronger impact on the economy and markets.

Fiscal Deficit and Debt Levels:

The U.S. government's fiscal deficit and debt levels are increasing significantly. Over the past few years, especially during the pandemic, government spending has increased dramatically to stimulate the economy, leading to rising deficits and debt levels. This increased fiscal burden could have implications for future economic policies and financial markets.

The impact of fiscal policy on the market:

The expansionary features of fiscal policy, such as increased government spending and tax cuts, could lead to economic growth and inflationary pressures. Such a policy could lead to changes in long-term interest rates, which could affect the performance of the bond and equity markets.

The relationship between fiscal policy and monetary policy:

The antagonistic relationship between fiscal policy and monetary policy is emphasized. While fiscal policy is expansionary, monetary policy may need to remain tight to avoid excessive inflation. This policy dichotomy may lead to new dynamics and investment opportunities in the market.

Long-term effects of fiscal policy:

Persistent fiscal deficits may lead to the need for higher taxes or reduced government spending in the future, which could have an impact on economic growth and market performance. Investors may need to rethink their portfolio allocation. In a fiscal policy-led environment, traditional asset allocation strategies may need to be adjusted to reflect new market dynamics and risks. Overall, fiscal expansion is likely to raise long-term interest rates.

Increase in debt levels:

The U.S. government's debt level has increased significantly since the pandemic, and this increase could lead to the need for the government to issue more bonds to finance it. When the supply of bonds increases, if there is not enough demand to absorb this additional supply, interest rates may rise as the government may need to offer higher returns to attract investors.

Fiscal Deficit Financing:

The need to finance fiscal deficits could lead to higher long-term interest rates. When governments need to borrow to cover their deficits, this increases competition for funding, which can push up borrowing costs. Long-term interest rates are affected by supply and demand, and if demand for government debt does not keep up with supply, interest rates may rise.

Inflation Expectations:

The expansionary nature of fiscal policy could lead to higher market expectations for future inflation. When the market expects inflation to rise in the future, investors may demand higher returns to compensate for the decline in purchasing power, which could also lead to higher long-term interest rates.

Policy Response:

To counter inflationary pressures that fiscal policy can cause, central banks may tighten monetary policy by raising short-term interest rates. This policy response may indirectly affect long-term interest rates, as the rise in short-term interest rates is usually passed on to long-term interest rates to some extent.

Economic growth expectations:

Fiscal policy stimulates the economy by increasing government spending and cutting taxes, which may raise economic growth expectations. Higher economic growth expectations are likely to increase the demand for funds, leading to higher long-term interest rates as investors expect more active economic activity going forward.

Market Confidence and Risk Appetite:

Changes in fiscal policy may also affect market confidence and risk appetite. If the market is concerned about the government's fiscal discipline and debt sustainability, this could lead to a rise in risk premiums, which in turn can push long-term interest rates higher.

Stability of the US dollar:

Although the dollar's share of global reserves has declined, the dollar has remained stable relative to other currencies. By comparing the Fed's policy stance and the budget deficit, it can be seen that the opposition between monetary and fiscal policies has a positive impact on the value of the dollar.

How investors can adjust their asset allocation strategies in the current market environment:

Re-evaluate the 60/40 portfolio:

Traditional 60/40 portfolios (equities and bonds) may need to be adjusted as bonds no longer offer the negative correlation of the past, which affects their usefulness as a diversification tool. Investors may want to consider reducing the weight of bonds and adding other types of assets.

Add Alternative Assets:

Investors are advised to consider increasing their allocation to alternative assets, such as liquidity alternatives, hedge funds, equity long/short strategies, and commodities. These asset classes may offer better diversification and may perform well in certain market conditions.

Consider the impact of fiscal policy:

In the current fiscal policy-led environment, investors should consider adding assets that may benefit from fiscal stimulus, such as certain equity sectors or sectors, as well as infrastructure-related investments that may be affected by government spending.

Focus on Gold and Bitcoin:

The rise in gold prices suggests that gold remains favored even against the backdrop of a stronger dollar and positive real interest rates, which may be related to fiscal dominance. Bitcoin, as another asset class, has likewise shown correlation with fiscal policy changes, but Bitcoin's rally has also been influenced by other factors, such as technological innovation and market acceptance, diversified currency risk:

For Canadian investors, it is advisable to increase the allocation of US dollar assets as a means of hedging against risks in the national currency. Not only can this provide diversification benefits, but it may also benefit from the relative strength of the US dollar.

Flexibility to adjust your strategy:

Investors should remain flexible and adjust their asset allocation in a timely manner according to changes in market conditions and economic environment. For example, if there is a change in the market, or if expectations for fiscal and monetary policy change, investors may need to reevaluate their investment strategy.

Pay attention to the source of income:

While reducing their bond allocation, investors should look for other sources of income, such as high-yield bonds, real estate investment trusts (REITs), or other assets that can provide stable cash flow.

Focus on corporate earnings:

As corporate earnings growth has a significant impact on stock valuations, investors should focus on companies or sectors that have strong earnings growth potential.

The recommendations highlight the need for flexible and diversified strategies to address potential risks and find new investment opportunities in an ever-changing market environment. By taking into account a variety of asset classes and market dynamics, investors can better protect their portfolios and seek long-term growth potential.

Future Market Outlook:

If inflation and employment data remain high, the Fed may not cut interest rates, which will have an impact on the market. Strong growth in corporate earnings is likely to reduce the market's sensitivity to changes in interest rates, as earnings growth can support higher equity valuations.

Q&A:

The question of the negative correlation of alternative assets explains that these assets are usually neither positively correlated nor negatively correlated with the bond market, but show zero correlation. The relationship between gold and the US dollar is discussed, and the possibility of gold as a hedging tool under the auspices of fiscal policy, while the interest rate policy of central banks may be influenced by fiscal policy.