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The Times They are A-Changin’

This year’s Annual Meeting of the International Monetary Fund (IMF) was held in a hybrid format from 11 to 17 October. As the coronavirus pandemic has started to abate, a number of finance ministers and central bank governors from some of the 190 member states travelled to Washington to attend in person, but many other delegations and guests still participated virtually. Christian Kopf, Head of Fixed-Income Fund Management at Union Investment, reports from the meeting and examines potential signals for the capital markets.

Christian Kopf

 

An article by Christian Kopf

Head of Fixed-Income Fund Management

Ever since my first participation in an Annual Meeting of the IMF more than twenty years ago, this event has been a firm fixture in my professional diary every October. Once per year, politicians, academics, investment bankers, representatives of international organisations and fund managers congregate for a few days of intense cross-pollination before buzzing off again with plenty of new ideas and insights. Due to the pandemic, this year’s meeting was held virtually for most participants for the second year in a row.

The event was dominated by an intense sense of hard-to-grasp change that I cannot recall ever having experienced quite like this at any previous meeting. It made the mood this year distinctly different from that at the meeting in October 2002 just after the burst of the dotcom bubble, or the meeting in Istanbul in October 2009 in the immediate aftermath of the global financial crisis. In both of those cases, the priority – especially for participants from the private sector – was continuity. Possibly combined with a few adjustments, steps to map out a ‘new normal’, but definitely a form of continuity. This time, there was a lot of confusion about the path ahead.

In part, this was down to the format of the meeting. It is simply much more difficult to properly gauge the situation when you cannot have informal chats with people in hallways and during coffee breaks. After all, many important developments that might be going on are not recorded in the written publications that accompany the meeting. And the lack of opportunities to discuss the day’s talks and debates with fellow attendees over dinner in the evening not only detracts from the breadth of information available but also weakens the focus on the core topics. However, the prevailing confusion was also partly attributable to the fact that many participants from the capital markets and the political sphere spoke a lot about ‘regime change’ but differed in their views about the nature of the turning points that we are approaching. Bob Dylan’s famous lines “Come writers and critics who prophesize with your pen / And keep your eyes wide, the chance won’t come again / And don’t speak too soon for the wheel’s still in spin” rang very true in the context of this event.

There was concern as to whether China might be heading for an economic crisis as a result of its aggressive regulatory intervention in the real estate market. Last year, Chinese regulators adopted three metrics for the maximum permitted debt ratio of property development companies. Businesses that exceed these ‘three red lines’ are not permitted to take on further debt. As a consequence of this, the company Evergrande was forced to file for insolvency. Payment defaults and a slowdown in the Chinese real estate sector are side effects that Beijing is clearly willing to accept. At the Annual Meeting of the IMF, there was broad agreement that the Chinese government cares very little about foreign creditors and shareholders. They will be last in line when it comes to the distribution of a liquidating dividend. However, it remained unclear whether President Xi and his government are in control of the consequences of their intervention in China’s domestic economy and Beijing’s characteristic lack of transparency is not helping to clarify the situation.

Deafening silence from WTO

There was also huge uncertainty about the future of global supply chains. It has now become clear that we are facing not merely short-lived supply squeezes but widespread disruptions that will persist for a prolonged period and affect many industries. This is attributable not only to the spike in overall demand in response to the easing of the coronavirus crisis but also to the reconfiguration of supply chains in light of growing political tensions between China and the West. Against this backdrop, the complete absence of the World Trade Organisation (WTO) from this year’s discussion panels felt very striking. Apparently, the WTO either has nothing left to say or it is struggling to make its voice heard. One way or another, it seems that the era of rules-based free trade is slowly but surely coming to an end. Any EU resident who has tried to order even the most mundane item from the UK in recent months will be able to attest to this. Going forward, supply chains will get moving again as the pandemic subsides. But over the medium term, a reorganisation of supply chains will create inefficiencies that could result in higher prices than we would like to see. This could have an impact on disposable incomes, economic output and employment.

The future of fiscal policy was another aspect that remained somewhat nebulous. It is still unclear how big the Biden administration’s planned infrastructure programme will be. Is it realistic for the US to commit to additional government spending of around US$ 2 trillion over a period of ten years? This would equate to about half the volume originally proposed by the current US government. And should this additional spending largely be financed through tax increases, or should government borrowing be increased? What adjustments the EU plans to make to its Stability and Growth Pact before the rules on budget deficits and public debt are reinstated in 2023 is no clearer. And German fiscal policy is equally up in the air. Will the new coalition government, whatever form it may take, be able to agree on an investment programme that taps the potential of established public sector entities such as Deutsche Bahn, the KfW development bank or even public real estate management agencies, while also staying within the confines of German ‘debt brake’ provisions?

The implications of high commodity prices differ fundamentally over the short and medium term. There was consensus that the OPEC+ countries are currently acting in a much more disciplined manner than most observers would have expected even a year ago. This is one of the reasons why oil prices have risen so substantially. Another factor is that cuts to investment in plant and equipment in the fossil fuel sector in recent years are now taking their toll because supply is running short. This is going to create inflationary pressure in the coming years and will strengthen the credit standing of countries such as Russia, Saudi Arabia, Kuwait, Nigeria and other oil-exporting nations. But if the decarbonisation trend continues to gather pace, the pendulum could – in the medium term – swing the other way entirely.

Against this backdrop, views about the outlook for inflation differed greatly. The IMF aimed to set out in its publications that annual inflation rates should come down in 2022. Given the pronounced low base effects, this seems evident and was not challenged by anyone. But there was no consensus about the trajectory of inflation beyond a six-month horizon. Most meeting participants expect slightly elevated inflation rates in the medium term. The IMF also warned that this would be a potential risk and that central banks should be prepared to tighten monetary policy as necessary.

Interest rates on the up – but not everywhere

What does all of this mean for monetary policy? I have rarely seen such a lack of consensus in a debate among central bank representatives. However, the divide seemed to run along generational rather than ideological lines. Many representatives of the older generation, who in their time in office used tough interest-rate increases to get a handle on inflation, openly admitted to being utterly dumbfounded by the inaction of the Federal Reserve and the European Central Bank (ECB). On the other hand, the generation of monetary policy makers who had been in office in the years after the global financial crisis of 2008 took the opposite view and warned against tightening monetary policy prematurely. The majority of those currently holding the monetary policy reins signalled willingness to shift to a more restrictive approach as a precaution against excessive inflation. Among the voices in this camp was Jim Bullard, President of the Federal Reserve Bank of St. Louis, who used to be considered a monetary dove in the past but is now pushing for swift tapering action.

The Federal Reserve and the ECB may not have taken action yet, but many other central banks have already adjusted their approach. Since the beginning of the year, 15 major central banks have raised their base rates and some of these increases, for example that of Poland’s central bank, have been surprisingly steep. The graph below shows that the average base rate of the G20 nations has already risen by more than 100 basis points.

Average interest rates G20 nations

Average interest rates G20 nations
Source: Macrobond, end of September 2021.

Ultimately, my takeaway from the debates at this year’s meeting is that there is currently enormous uncertainty about the new macroeconomic regime for the post-coronavirus era. In the words of Bob Dylan, “the wheel is still in spin”. But monetary policy has already started to tighten.

 

As at: end of September 2021.