As this historic November ended, the message from the financial markets seems clear: For now, the outlook for the US economy appears brighter, both in absolute terms and relative to other advanced economies.
Very few predicted these developments, which speak to the enormous fluidity that has taken over markets and politics and that signal the gradual end of the “new normal”. This could lead to two contrasting outcomes depending on how politicians respond in the next few months.
The strong rally in stocks and the dollar, along with the notable rise in yields on government bonds, demonstrate that markets have embraced the likelihood of higher growth and higher inflation for the US. In doing so, they have differentiated the US from other advanced economies, many of which are deemed to be facing significant growth bottlenecks, as well as institutional uncertainties.
As a result, US stocks have outperformed European ones. At the same time, the sharp rise in US interest rates, which produced the worst month for the bond market since 2009, has broken a long-standing trading band for the differential between 10-year Treasury yields and German Bunds of the same maturity.
This has unfolded on the back of two major developments that were deemed unlikely just a month ago: Donald Trump winning the presidential election and, due to his initial economic remarks, its reading by markets as a “risk-on” event. It has also helped that relations between the president-elect and the Republican establishment that now holds majority in both houses of Congress have thawed.
The first development demonstrates how today’s politics of anger enable anti-establishment movements and empower them to upend traditional political assumptions and defy expert opinion. The second speaks to the markets’ yearning for a pro-growth rebalancing of a policy mix that has relied on central banks for too long.
Together, they show what happens to sophisticated democratic economies that are stuck in a prolonged period of low and insufficiently inclusive growth.
New normal
What happened in November is a symptom of a much bigger phenomenon that is playing out in a growing number of advanced economies. The “new normal” -- low but stable growth accompanied by central banks both able and willing to repress financial volatility — is being gradually undermined by myriad political, financial, social, economic and institutional factors, as I pointed out in my recent book, The Only Game in Town.
Frustrated citizens are urging the political system to make changes. And politicians who respond by signalling their intention to implement pro-growth measures — as President-elect Trump has done in the very early days after his victory — will be rewarded first with better financial market sentiment and, if sound design and proper implementation follow, by an increased flow of corporate cash into investments on plant, equipment and people.
But should the policy effort falter or prove insufficiently serious. or should it fail to materialise altogether, the private sector would likely retrench, raising the risk that low growth yields to recession, as artificial financial stability gives way to unsettling volatility.
These November messages need to be heard by political classes on both sides of the Atlantic.
