Why Financial Markets’ New Exuberance Is Irrational
Owing to a recent easing of both Sino-American tensions and monetary policies, many investors seem to be betting on another era of expansion for the global economy. But they would do well to remember that the fundamental risks to growth remain, and are actually getting worse.
NEW YORK – This past May and August, escalations in the trade and technology conflict between the United States and China rattled stock markets and pushed bond yields to historic lows. But that was then: since then, financial markets have once again become giddy. US and other equities are trending toward new highs, and there is even talk of a potential “melt-up” in equity values. The financial-market buzz has seized on the possibility of a “reflation trade,” in the hope that the recent global slowdown will be followed in 2020 by accelerating growth and firmer inflation (which helps profits and risky assets).
The sudden shift from risk-off to risk-on reflects four positive developments. First, the US and China are likely to reach a “phase-one” deal that would at least temporarily halt any further escalation of their trade and technology war. Second, despite the uncertainty surrounding the United Kingdom’s election on December 12, Prime Minister Boris Johnson has at least managed to secure a tentative “soft Brexit” deal with the EU, and the chances of the UK crashing out of the bloc have been substantially reduced.
Third, the US has demonstrated restraint in the face of Iranian provocations in the Middle East, with President Donald Trump realizing that surgical strikes against that country could result in a full-scale war and severe oil-price spike. And, lastly, the US Federal Reserve, the European Central Bank, and other major central banks have gotten ahead of geopolitical headwinds by easing monetary policies. With central banks once again coming to the rescue, even minor “green shoots” – such as the stabilization of the US manufacturing sector and the resilience of services and consumption growth – have been taken as a harbinger of renewed global expansion.