Uncertainty – the enemy of growth and central banks’ burden to bear, for now
Uncertainty ratcheted up to new levels last week, with the now-you-see-it, now-you-don’t and oh-now-you-do-again Mexican trade deal. Central banks stepped into the breach with commitments to use the firepower they have to withstand the fallout from Trump’s ‘weaponised’ trade policy.
If there was ever a time that highlights that uncertainty is, indeed, the enemy of growth, it is now. Since the beginning of May, few would argue that uncertain times have become even more unpredictable as US President Donald Trump has chopped and changed decisions on the trade front and financial markets have whipsawed in response.
Why is uncertainty such a corrosive economic force? The Business Dictionary’s explanation of uncertainty as a concept is as follows:
Decision making: Situation where the current state of knowledge is such that (1) the order or nature of things is unknown, (2) the consequences, extent, or magnitude of circumstances, conditions, or events is unpredictable, and (3) credible probabilities to possible outcomes cannot be assigned.
All three of these consequences understandably play havoc with our decision making in the short-, medium- and, in periods of protracted uncertainty, in the long-term too.
Last week’s events highlight the short-term impact of unpredictable circumstances, conditions or events. Internationally, Trump’s out-of-the-blue threat to impose tariffs on Mexico caught everyone completely off guard. It prompted market commentators to question whether, going forward, it would be possible to trust that a trade deal could be relied on to remain a trade deal under his watch.
In addition, Trump was seen as weaponising trade, introducing a huge element of uncertainty that is unlikely to have been dispelled when the first round of tariffs due to be implemented on Mexico on Monday was put on hold and a deal was reported to have been struck.
Adding to jittery sentiment, Friday’s shockingly low US job growth figures undershot expectations by 100,000 and saw analysts divided on whether they were something to worry about in the context of trade tensions or whether they were merely a temporary blip in an otherwise healthy job creation trend.
At home, South Africa experienced its own drama, adding to the pervasive uncertainty dogging the economy. The debacle around whether the ANC did, or did not, intend to broaden the Reserve Bank’s mandate and institute quantitative easing created havoc in financial markets. The rand raced up to R15 to the dollar and the uncertainty it invoked decimated the baby steps Cyril Ramaphosa was making in convincing local and international investors that he was ready to move forward with vital structural economic reform. That the news came hard on the heels of news of a dismal economic contraction in the first quarter, didn’t help gloomy sentiment at all and left onlookers flummoxed and disconcerted.
These unsettling events notwithstanding, equities went on to put in their best weekly performance this year. This counterintuitive response was driven by investor expectations that central banks would come to the rescue, with the market ultimately pricing in a whopping three US rate cuts totalling 75-basis points by the end of the year. There was much discussion about whether markets could expect an “insurance” rate cut as early as July.
These short-term events and the market’s unexpected response highlights how uncertainty triggers unforeseen outcomes and often results in asset prices diverging from their underlying valuations – either temporarily or on a longer-term basis. This subverts economic reality, favouring traders and distorting the decision-making framework for fundamental investors and other rational economic stakeholders.
Eliminating uncertainty in the medium term falls to the central banks as the only policy-making bodies that have succeeded in fostering any semblance of confidence and certainty since the financial crisis in 2008. They will be hard pressed to counter the knee-jerk decisions that are being taken by politicians and government leaders.
Over the past week the largest central banks have stepped up to the plate, with the central bank governors of the Bank of Japan, the People’s Bank of China, the US Federal Reserve and the European Central Bank all publicly confirming they will use the firepower they have if they see the trade tensions erode global growth prospects any further.
Trade tensions were the subject of much attention at the G20 Finance Ministers and central bankers summit in Japan this weekend. But the firepower of the central banks is varied and, in the case of the US and Europe, limited because interest rates are close to the lower bound.
Last week US Federal Reserve chairperson Jerome Powell spoke at the outset of the Chicago session of its Fed Listens tour being rolled out this year. During his opening remarks, Powell pinpointed the effective, or zero, lower bound as the pre-eminent monetary policy challenge of our time, raising “all manner of risks”.
He pointed out that the last time the US was in a similar situation when it had to conduct monetary policy in a low inflation environment was in 1999. At that time the interest rate was 20 quarter-point rate cuts away from the lower bound compared with half that today, given that the Fed Fund rate is at 2.5%.
While Powell didn’t refer directly to whether rates were likely to decline this year, he did discuss the dot plot, which many market participants use as an indication of what can be expected from interest rates in the medium-term.
“The focus on the median forecast amounts to what the typical Federal Open Market Committee participant would do if things went as expected. But we’ve been living in times characterised by large, frequent, unexpected changes in the structure of the underlying economy. In this environment, the most important policy message may be about how the Fed will respond to the unexpected rather than what it will do if there are no surprises.”
He commented that unfortunately at times the dot plot has distracted attention and that in times of high uncertainty, the median dot plot “might best be thought of as the least unlikely outlook”.
His comments highlight how concerned he is about uncertainty and the extent of the responsibility to manage the uncertainty that currently lies on the shoulders of central banks.
We cannot afford to continue experiencing the long-term consequences of uncertainty. PWC, in its Global Economic Watch, pinpoints what happens to the decision making of economic stakeholders during prolonged periods of uncertainty:
• Consumers cut back on spending and save more
• Businesses cut back on production, investment and employee compensation
• Financial markets are typically more volatile with higher risk premia.
With the South African economy long the victim of political uncertainty, with no relief yet in sight, it’s not surprising that SA’s gross fixed investment is 5% lower than it was at the end of 2017. In the first quarter of this year alone, it contracted more than 1% from its fourth-quarter level.
Without investment, there can be no growth so until political and economic actors come together and pull in the same direction, sustainably uncertainty will prevail and the economy will remain mired in purgatory. BM
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