The new regime - "Money Debt Hangover" after the pandemic and lockdown

 

Economic and financial history can often be defined by simple regimes or environments that define large directional moves and biases in the financial markets. After the fact, these regimes seem very clear albeit there may be disagreement on what are the defining characteristics. These regimes cannot always be described in quantitative terms but are often characterized through a simple narrative. 

The "Great Moderation" which was signaled by inflation targeting was far from it given some of the crises during this period. The EMS, Mexican debt, and Asian debt crises, however, busted any idea of moderation for short periods. The period of Reaganomics and monetarism included the Latin American debt crisis, currency dislocations, the '87 crash, and the thrift crisis. 

Before the fact, these regimes may be discussed by market analysts in broad terms but are still ambiguous enough to not provide strong guidance to most investors. All of these regimes take time to develop. We are in one of those transition times and those who identify the environment first will be rewarded.  

The vaccination programs are working. Lockdowns and restrictions are being adjusted to the current situation. Fiscal and monetary policy have been used to offset the economic shock, so the old pandemic regime is ready for a full transition. Investors have been anticipating this event for some time although there have been bumps along the road, yet it is not clear what will be the reaction in markets.  

The global bond shock is an early sign of capital further adjusting to the transitions. Markets are forward-looking, so it should be expected that they get ahead of any new regime world. There are two core problem or questions for investors as they for form these forward-looking views. First, what are the economic recovery paths and is the only way these paths can be achieved is through monetary-fiscal support. At what point is a recovery sustainable enough to allow for the payment of the stimulus and the return to normalcy? China is ready to for the transition. The US may be preparing for transition. The EU may be behind with this transition. Second, what will be the reaction of markets to this recovery path? What is the a normalized equity or bond market? How much pain will be associated with transitioning to a normal market?  

Questions are associated with whether markets are ahead or behind the transition and are policy-makers ready or accepting of the new regime. Ask Fed officials and they will tell you that any "money debt hangover" is not supposed to begin for at least for another two years. Ask politicians and they will say the stimulus was needed to jump-start or speed the recovery. Markets may have a third view that does not agree with either.