Dissecting the Market Disconnect
Episode publishedPodcast: Goldman Sachs ExchangesGoldman Sachs Exchanges
Transcript preview
Preview only
From Goldman Sachs Research, this is Alison Nathan. Welcome to Top of Mind, a podcast that explores macroeconomic issues on the minds of our clients. In this episode, we're taking a look at growth uncertainty, which has been on the rise given the age of the economic expansion, now the longest on record, and risks from trade tensions as well as other political uncertainties like Brexit. Here's Christine Lagarde, chairwoman of the International Monetary Fund and newly nominated ECB president earlier this year. The
bottom line is that after two years of solid expansion, the world economy is growing more slowly than expected, and risks are rising.
Growth concerns have been at the heart of the dovish pivot we've seen from central banks this year, and markets and our economists alike now expect the Fed to start delivering rate cuts as soon as this month. Here's Fed chair Jerome Powell testifying on Capitol Hill just last week.
At our June meeting, we indicated that in light of increased uncertainties about the economic outlook and muted inflation pressures, we would closely monitor the implications of incoming information for the economic outlook and would act as appropriate to sustain the expansion.
The market reaction to all of this has been noteworthy. Typically, when growth concerns rise, investor demand shifts towards less risky assets. That means investors usually buy bonds, causing yields to decline, and sell stocks, causing equity prices to fall. But recently, we've generally seen the reverse with bond yields declining while stock prices have risen to all time highs. Many think this is because fed cuts are just protecting against a downturn rather than actually responding to one. But others think stocks and bonds are sending very different messages about growth with bond investors
Stock values are fundamentally determined by the present value of expected cash flows. And when interest rates go down, that's a positive for stocks in a present value sense. So when I look at the decline in interest rates and the move to a more stimulative Fed policy, I look at that as a temporary positive effect on stocks but that it is a non sustainable effect on stocks for the long run because there is a limitation as to how far interest rates can go down and how quantitative easing can work. So when interest rates go down, it causes the present value of assets to rise, but, it also means
Dalio is concerned that the Fed and other central banks are running out of stimulus, he also thinks the Fed's shift to a more dovish monetary policy was appropriate and, if anything, could have come sooner. And he doesn't give much credence to the view that the Fed has been too responsive to bond market concerns. Here's what he had to say on the Fed.
They would worry too much about a strong economy with limited capacity to expand, and they were worried about the combination of the fiscal stimulation and the low rates of employment and that inflation would accelerate. They were very worried about the classic cycle happening. In my opinion, too worried about that. And so going into year end, they over tightened it and they, then did a sharp reversal. My opinion, an appropriate sharp reversal because the inflation risks and the growth risks are exaggerated. But
ultimately, there is a narrative in the markets now and that the Fed has been overly responsive to bond market pricing. So just to clarify, you don't agree with that?
Keep exploring with a free account.
A free account preserves the short preview. Upgrade to Pro for the full transcript and episode chat.