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The once resolute “whatever it takes” message of government support for pandemic-hit economies is fraying at the margins as some recovery from the COVID-19 shock emerges, leaving buoyant markets pondering the prospect of ebbing stimulus.

Government ministers are starting to stress that borrowing can’t keep rising at this year’s pace for much longer, even though winding down fiscal action at a time when the rebound is incomplete, and the virus still spreading, could be jarring.

But investors insist that leaves central banks back doing the heavy lifting once more, suppressing borrowing rates for years to come to keep affordable the highest stock of developed world government debt relative to output since just after the Second World War and regardless of any pickup in inflation.

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And the deeply negative long-term “real,” or inflation-adjusted, borrowing rates this delivers – currently less than minus 1 per cent in the United States and parts of the euro zone on a 10-year horizon – has already supercharged the parallel surge in equities, bonds, gold and property over recent weeks.

While forecasters such as Deutsche Bank and Goldman Sachs have scaled back the extent of their expected 2020 economic contractions, their interest rate horizon barely changes at all.

“We expect monetary policy to remain highly supportive, with no hikes from the Fed until early 2025,” Goldman’s chief U.S. economist Jan Hatzius told clients on Monday.

What’s more, market pricing still hasn’t ruled out the possibility of Federal Reserve policy rates going negative over that horizon despite routine pushback from Fed policy makers.

But that easy money vista is starting to mirror signs of fiscal exhaustion.


After months of governments insisting they would spend any amount of money to protect business, jobs and incomes hit by pandemic lockdowns, signs of recovery as restrictions have lifted this summer have prompted a change of tone.

Congress and the White House hit the buffers this weekend in talks on rolling over additional income support and on how much is needed to keep the economy moving.

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Unilateral White House action is bridging the gap as talks are likely to resume, but U.S. Treasury Secretary Steve Mnuchin is already intent on flagging the limits of what’s likely.

Pushing back against congressional Democrats’ demand for another spending tranche in excess of US$3-trillion, Mr. Mnuchin said Washington needed to be “careful about not piling on enormous amount of debts for future generations.”

His British counterpart, Rishi Sunak, arguing against the extension of the British government’s job furlough scheme beyond October, echoed the sentiments last Friday by saying government couldn’t keep borrowing at this year’s rate.

“That’s not something we can or should sustain,” Mr. Sunak said.

So much for “whatever it takes.”

Many investors insist the more cautious spending tone is merely commensurate with the recovery in activity and spending would ratchet higher again if there were another severe downturn because of new virus restrictions or a long delay in a vaccine.

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Sonal Desai, fixed income chief investment officer at Franklin Templeton, says policy makers had shown themselves to be incredibly flexible and she doesn’t doubt they would step up again if needed.

But she said markets would need to prepare for some volatility when fiscal and monetary supports end, and this would help decide how much of market pricing is based on reasonable recovery expectations and how much is artificially supported by temporary policy stimuli.

“The Fed can’t do this indefinitely,” she said. “Not unless you see Japan-style deflation.”

And, not for the first time, it’s the fear of stimulus distortions in financial markets that may be the most powerful argument for rethinking the scale of monetary support over time.

Morgan Stanley analysts this week flagged how the investment world’s aggregate “duration” – or sensitivity to interest rate moves – was at unprecedented levels.

They pointed out the duration of global catch-all bond indexes had risen about 5 per cent in two years to record highs as firms and governments used record low rates to extend maturities.

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But it was also true in equities, where exposure to consumer discretionary sectors, dominated by Inc., had the highest negative correlation to U.S. real yields. The supercharged technology sector is close behind and both sectors are rising proportions of broad equity and bond market capitalization.

“Globally, investors hold $8.1 trillion more of these yield-sensitive sectors than they did just about 18 months ago,” the Morgan Stanley analysts wrote.

Even the hedge of gold and silver, which have also been surging of late, may be a real rate expression and hence long duration, they conclude.

Whether that potentially dangerous market skew makes central banks rethink easy policies soon or whether it traps them there to avoid disruption is the crucial question over the year ahead.

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