A lot has been said about MMT in recent years. To begin turning all that opinion into an actionable framework, we think there are a handful of principles that should guide investor thinking about MMT.
- The adoption of MMT by policymakers is not binary; we should think in terms of a spectrum, or ‘thermometer’
- A structural break in the long-term history of how monetary and fiscal policy is conducted has been forming; structural breaks have implications for portfolio construction
- As policymakers move along the spectrum, they won’t use the term ‘MMT’; we must look for related themes, and it will be these themes that will be investable, not the MMT theme itself
The thermometer
There has recently been a distinction between conventional and unconventional monetary policy. This distinction is becoming outdated and that it is better to think in terms of a spectrum. The setting of interest rates is hardly the main policy tool for many central banks anymore and we think it would be unwise to take for granted the order of policy settings (e.g., rates can rise with QE still in force). Perhaps most importantly, this discussion is no longer just about monetary policy but about the co-ordination between monetary and fiscal policy.
The structural break
This is not the first structural break in the way that monetary/fiscal policy is conducted. If we had to choose a single variable, then looking back at history, we find that inflation reflects structural breaks in the policy regime. We would argue for using the inflation regime as a starting point for understanding the behaviour of other variables following the structural break that is upon us. Therefore, keep a close eye on the inflation response function to this shift in policy regime.
In terms of the relationship between the major asset classes, we find that the correlation between equities and bonds also goes through regimes, mapping closely to the aforementioned inflation regimes. It will be interesting to observe the correlation response function as this shift in policy takes a foothold in equity and bond market dynamics (assuming there is still a bond market). If inflation comes through, historical precedence suggests a rising correlation. But a word of caution; the reason for this shift in policy regime is because absolute nominal bond yield levels are at their lowest ever. If real bond total returns in the near future are driven more by inflation than by coupon income (in part because policymakers are willing to remain behind the inflation curve), we think equity/bond correlation could remain negative for longer than some commentators think.
Observing the shift to MMT through related investment themes.
As it becomes more of a reality, MMT will no longer just be a ‘theory’, it is unlikely to be labelled as ‘modern’, and the delivery of the policy will be through fiscal-monetary coordination, rather than just by monetary authorities. Don’t expect it to be called ‘MMT’ as and when it creeps into mainstream policy.
With that in mind, here are some things to look out for:
Macro
- Lower real rates as nominal interest rates lag inflation (after the initial deflationary shock has subsided)
- Shallow growth paths as economies struggle to get their real rates low enough to escape secular stagnation, suggesting they will need to remain hot on the policy thermometer
- Signs that rates could possibly rise from the zero lower bound, even with other expansionary monetary and fiscal policies still in place, suggesting that policymakers are willing to operate at multiple speeds
- Signs of labour shortages; a shortage of real resources is the main constraint against expansionary policies being effective in generating stable real growth
- Signs of increased government spending on technology as they recognise that improvements in total factor productivity are required to prevent shortages of labour (there’ll be no shortage of capital)
- An increased proportion of consumer and government spending going to healthcare and education
- Increased willingness by the DM majors to forgive international debt
Asset classes
- Inflation protection to be in demand. Whether inflation comes through or not, fears of an uncontrolled inflationary spiral will be higher than they were in the recent past
- Gold to be back in vogue as money printing calls into question the viability of paper money
- Speculative activity in potential new media of exchange such as cryptocurrencies
- Real assets with a useful life to benefit as they will hold their value in real terms
Sectors
- An increase in the number of zombie companies as the capital structure of some companies begins to mimic that of their government
- The construction industry to benefit as the newly printed money is used to finance infrastructure projects
- Healthcare and education sectors to benefit as the newly printed money is directed disproportionately towards them (not necessarily because of the coronavirus, but because of the ‘cost disease’, which suggests that in a world of technological progress the cost of labour-intensive services rises relative to the cost of manufactured goods, because productivity gains are harder to come by in labour-intensive services. This makes it less likely that the private will provide them, and more likely that the public sector will have to step in).
- The technology sector to benefit because it is the means by which the abovementioned cost disease is overcome.
We’d love to hear your views. Please comment below or get in touch.
To the pound 