Over the past few years, investors have tended to be richly rewarded for setting aside traditional determinants of market value and focusing on just one thing: plentiful and predictable liquidity injections into the marketplace. But this dynamic cannot last forever, and it may confront a moment of truth in the fourth quarter of 2020.
CAMBRIDGE – Having long been buttressed by ample liquidity, financial markets are entering the final quarter of 2020 amid an increasingly tentative global economic recovery, unusual political uncertainties, and lagging fiscal and structural policy responses. And these headwinds come on top of the COVID-19 crisis, which has left most countries struggling to strike a balance between protecting public health, achieving a return to a semi-normal level of economic activity, and limiting infringements on individual liberties.
In this context, the hope is that today’s generous liquidity conditions, enabled and supported by central banks, will continue to provide a bridge to a better 2021, not only reversing the economic and social damage, but also delivering further gains to investors. But will this bridging operation, already deployed for several years to compensate for other headwinds, be sufficient to overcome what is an increasingly complex pandemic cocktail?
Recent economic data indicate that, outside of China and few other countries, the economic recovery remains uneven and uncertain, and is falling short of what is both needed and possible, in my opinion. Travel, hospitality, and other service-sector activities continue to face considerable challenges, complicating the overall employment picture. Moreover, a growing number of companies in other sectors are pursuing “re-sizing” initiatives that will likely lead to less hiring or even a wave of layoffs.
Adding to these economic challenges are deepening political uncertainties, especially in the United States. An already highly uncertain election process has been further complicated by President Donald Trump’s COVID-19 infection. And now that a number of lawmakers have also contracted the virus, congressional deliberations on many vital matters have been delayed. The US Senate has been left with little time to consider anything other than the nomination of a new Supreme Court justice, which the Republican majority insists on pushing through before the end of Trump’s term. As a result, there is only limited hope for a new fiscal relief package, pro-growth structural reforms, or any other meaningful US policy initiatives in the next few weeks
Meanwhile, US participation in multilateral policy deliberations – not to mention America’s global leadership role more generally – remains curtailed. Making matters even more complicated, economic and financial responses elsewhere are also hitting a ceiling, particularly in the developing world, where governments are running out of policy space, owing to high deficits, rising debt, and more shaky currency dynamics. This policymaking uncertainty is being magnified by the larger struggle to meet the three main objectives of the pandemic era: maintaining public health and protecting citizens; avoiding further damage to the social fabric, economic welfare, and financial viability; and minimizing restrictions, also in the interest of avoiding “pandemic fatigue.”
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