THE TUG OF WAR GROWS MORE FRAUGHT FOR INVESTORS / THYE FINANCIAL TIMES

The tug of war grows more fraught for investors

The IMF and World Bank meetings mixed optimism about the global economy with plenty of concerns

by Mohamed El-Erian
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© Bloomberg


A “Yes, but” emerged from last week’s global gathering of policymakers that provides a comprehensive check-up for the global economy. In Washington for the 2017 Annual Meetings of the International Monetary Fund and World Bank, officials from almost 190 countries mixed excitement about the improving prospects for the global economy with caution about a list of actual and potential challenges.

And with both sides of this ledger having grown during the past few months, it is a configuration that amplifies the contradictions that traders and investors have to navigate down the road but, for now, are comfortable to profitably ignore.

Four factors underpin the “Yes”:·

- A pick up in economic growth that is becoming broader and more durable. The IMF now projects global growth to increase from 3.2 per cent last year to 3.6 per cent in 2017 and 3.7 per cent in 2018.

- Loose financial conditions that support consumption, and do so without a worrisome increase in inflation and inflationary expectations.

- Very low financial market volatility that, now common to virtually all market segments, allows the wave of higher valuations to reach far and deep.

- Hope that economic growth could be turbocharged by long-awaited progress in implementing more pro-growth policies, particularly in Europe and the US.

The “But” list includes:

- Limited understanding of key economic relationships in advanced countries (such as productivity, wage determination and inflation dynamics), as well as the impact of technological innovation.

- The “hot potato” dimension of today’s foreign exchange markets in which virtually no country is able and willing to live with a sustainably stronger currency.

Uncertainties about the impact of an eventual normalisation of monetary policy in more than one systemically-important central bank, together with those relating to trading arrangements in Europe and North America.

- Growing backlash against big tech in the context of a catchup, both by governments and the companies themselves, to the sector’s systemic importance.

- An international economic order facing greater probability of fragmentation along national and regional lines.

- The geopolitics of North Korea’s brazen nuclear threats.

- Persistent inequalities that fuel the politics of anger, social divisions and party polarisation.


While both sides of this ledger have increased over time, traders and investors have been profitably focusing elsewhere — that is, applying a “buy-the-dip” (any dip) strategy that has served them well. It involves ever greater exposures to credit, liquidity and volatility risks that, over the past few months, have spread from advanced countries’ stocks and bonds to virtually every corner of the public markets around the world. And it is a phenomenon that is being structurally embedded through the proliferation of a growing array of low-cost passive products, notably ETFs, that implicitly promise investors instantaneous liquidity at reasonable bid-offer spreads in asset classes that, in the past, have suffered numerous liquidity strains.

Over time, this confluence of factors sets the global economy and markets on course for a tug-of-war among dramatically opposing possible outcomes. If the “Yes” prevails, the result would include higher and more inclusive growth, a validation of elevated asset prices, the orderly normalisation of unconventional monetary policy, reduced cross-border tensions and an improved environment for national politics. However, a decisive tip towards the “But” would threaten recession and unsettling financial instability, increase the risks of a policy mistake, worsen trade and currency tensions, and fuel more divisive national politics.

It is very hard to predict with a high enough degree of confidence the timing and direction of the eventual resolution. In the meantime, only major disruptions are likely to dissuade traders and investors to abandon what most dream of — a strategy that reliably rewards them and even has some legitimate justification (that is, the ample availability of liquidity from central banks and the corporate sector). In the meantime, both sides of the ledger will continue to grow.


Mohamed El-Erian is chief economic adviser to Allianz and author of the book ‘The Only Game in Town’