The Strategist

Experts and officials call to stimulate economies with state expenditures

10/28/2016 - 16:32

A few years ago, many experts called for fiscal austerity, and investors feared that xcess costs would hit the government bond market. In 2011, investor Bill Gross, then ruled the world’s largest bond fund Pimco, sold US Treasury bonds saying that British bonds were based "on a nitroglycerine bed".

Nowadays, Gross is urging to increase spending. There are signs that governments are willing to change their courses, the more so the leading developed countries have significantly reduced the budget deficit, and Germany even went in the black.

British Prime Minister Theresa May criticized the Bank of England’s ultra-soft policy. The country’s finance minister Philip Hammond is now emphasizing the need to increase spending on infrastructure and housing construction. The European Commission in July decided not to penalize Spain and Portugal for the excess costs. The IMF, which praised fiscal austerity since the Greek debt crisis in 2010, is now calling upon the government to dip into their pockets. Washington "is not arguing what is better – growth or savings. Rather, they are talking about how to make best use of fiscal policy to support the economy," said Jack Lew of the US Treasury.

"Earlier, people thought that [fiscal] stimulus are evil and it is necessary to balance the budget. Now, however, they realize that nothing is working" - said Mike Riddell, a Fund Manager at Allianz Global Investors.

By reducing the costs, government have provided central banks with all opportunities to fight recession and stagnation. Near-zero rates and monetary incentives contributed to phenomenal growth of financial markets, yet did not solve economic problems. Households and companies, which were supposed to take advantage of cheap lending to increase spending, refused to raise their debt burden. Thus, ultra-low interest rates affected the population's savings and banks themselves.

Bank shares indices fell by 20 and 29% since the beginning of the year in the euro area and Japan, respectively. New fiscal stimulus policy is expected to change the situation and balance of power in the financial markets as a whole, analysts say. "We are leaving this certain and welcoming investment environment, and are moving to a new world," - said Guy Monson, CIO at Sarasin & Partners Investment.

First signs of change are already visible in the government bond market. Yields of the UK’s bonds jumped sharply after statements of May and Hammond. In Germany, yield on 10-year bonds is now 0.007%, while it was below zero during most of the summer.

Growth in global demand after introducing fiscal stimulus support commodities, exporters and builders. Industry index of American engineering and construction companies has increased by 18% since the beginning of the year in anticipation of a change of government policy. To compare, it lagged far behind the market as a whole in 2014. Rise in the commodity market is expected to help developing countries, although strengthening of the dollar and associated outflows to developed markets may create temporary problems. "If expectations on terms of interest rates and yields of bonds grow, it may to cause volatility in emerging markets in the short term. In general, however, this development is positive for global economic growth," - says Stephanie Flanders, Chief Strategist for European markets at JPMorgan Asset Management.