In Focus: Fixed income  

We have moved beyond the world once characterised as the new normal

Daniel Ivascyn

Daniel Ivascyn

The world is fragmenting. This fracturing had already been underway with the emergence of China as a major economic and geopolitical player and western governments’ skeptical stance toward China. 

The war in Ukraine and the responses to it are widening these geopolitical fractures and could accelerate the move from a unipolar world to a bipolar or multipolar world.

In the medium term we see an elevated risk of recession over the next two years, reflecting greater potential for geopolitical tumult, stubbornly high inflation that reduces households’ real disposable income, and central banks’ intense focus on fighting inflation first, which raises the risk of financial accidents on top of the sharp tightening of financial conditions already seen.

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Moreover, if and when the next recession arrives, we expect the monetary and fiscal responses to be more reserved and arrive later than in the last several recessions when inflation was not a concern and when government debt levels and central bank balance sheets were less bloated.

While for many reasons our view is that the next recession is unlikely to be as deep as the great recession of 2008 or the Covid sudden stop of 2020, it may well be more prolonged and recovery may well be more sluggish due to a less vigorous response by central banks and governments.

Reaching for resilience

In a more fractured world, we believe governments and corporate decision-makers will increasingly focus on searching for safety and building resilience.

With the risk of military conflict more real following Russian aggression toward Ukraine, many governments – especially in Europe but also elsewhere – have announced plans to increase defence spending and invest in both energy and food security.

Many corporate decision-makers are focused on building more resilient supply chains through global diversification, near-shoring, and friend-shoring.

These efforts were already underway in response to US/China trade tensions and because the Covid pandemic demonstrated the fragility of elaborate value chains, and are likely to be intensified given the more insecure geopolitical environment.

Moreover, in response to climate-related risks and the Covid crisis, most governments and many companies have already increased efforts to mitigate and adapt to global warming and to improve health security for their citizens and employees.

We believe that we have firmly moved beyond the world that we once characterised as the new normal of subpar but stable growth and inflation stubbornly below central banks’ targets.

During that period, many investors were rewarded for reaching for yield and for buying the dip, anticipating central bank action and – during the Covid pandemic – fiscal policy support for risk assets.

However, over the secular horizon we believe that central banks may be less able to suppress market volatility and to support financial asset market returns.