The business cycle

The new normal: infinite QE and higher rates

By March 18, 2020June 11th, 2020No Comments

There are so many moving parts these days that it is easy to feel completely lost about the present, let alone the future. So, let us pin down the big trends unfolding. This is our interpretation of the past, present and future.

The past: even before the coronavirus outbreak, the US and the Eurozone were at the end of their respective business cycles. The monetary transmission mechanism was losing effectiveness and the purchasing power of households was more constrained than what the statistics would have shown you because there was more inflation than what we can measure and less income growth than what we can monitor.

The present: the coronavirus epidemic has hit everyone, and the experience of Italy is being replicated pretty much across Europe and the US. So, we are looking at a recession worse than the 2009 downturn. Remember that it is not just the virus outbreak that is the problem, we will inevitably go through the phase of balance sheet restructuring.

The future: the scale of the adjustment is vast, nothing short of unlimited quantitative easing, in our view, will work to stabilise the situation. The monetary transmission mechanism needs to be more effective. This means more unusual measures and, here, Hungary leads the way. Aggressive issuance of retail bonds priced at a premium helps diversify the investor base and secure funding, while providing some extra income for households at the same time. You may think that it is expensive or unjust. I reply: it is going to be as expensive as the size of the programme and certainly less expensive than a financial crisis. Unjust? If you issue small tenors, even those that have small savings will be able to get something more than zero, or even negative. Equally important will be to inject liquidity that will reach SMEs in the form of loans with sufficiently long maturities and at a set low price. It is important that we do not just focus on the ultra-short term, but also create the conditions for entrepreneurs to safeguard and develop their business models, and that needs years, not days.

There will be plenty more unusual measures ahead. If you think these two are unacceptable, you do not have the appropriate appreciation of the changes in the next two years. Maybe now is a good time to subscribe to our research!