In the last few weeks there has been a prominent voice siding with more radical interpretations of the status and path that the global economy is on. Claiming the beginning of the Dollar’s debasement, it is the voice of Goldman Sachs that now brings the market a stark warning about government debt and tech valuations. The paradigm of a strengthening US Dollar, falling global bond yields and soaring tech valuations has been with us for at least a decade, many would argue closer to two. To publish attacks on all three of these phenomena within the space of a week signals to the market Goldman’s belief in a fundamental shift in the global political economy.
The call of a debasing US Dollar from the leading investment bank goes further than many market participants’ belief of a shift in sentiment against the greenback and a move away from risk. Debasement occurs when an asset or entity changes so significantly that it’s very fundamentals are incomparable over two time horizons. In Goldman’s opinion, economic fundamentals, political uncertainty and the pandemic response measures thus far create a significant disturbance to the drivers of the US currency so as to warrant a complete reclassification of its strength and even position in the world. There are relatively few market participants persuaded by the debasement story so far.
During the course of the pandemic central bank balance sheets have been raised by 20% to 120% of GDP in Japan, increased by half to 60% in the Eurozone, and expanded by $3tn in the United States. The vast amount of new liquidity in markets has driven yields lower as the central bank has soaked up any excess supply of government debt not purchased in the open market. Goldman warned yesterday in a note that the early discovery of a coronavirus vaccine could force a cyclical rotation from government debt into more risky assets. The bank suggested that the risk of discovering and approving a vaccine this year has not been priced into the market sufficiently. If this event did materialise the bank suggests it would be sufficient to question assumptions about eternally negative real rates.
Over in the United Kingdom this morning the Bank of England convened early to publish their latest monetary policy decision. They kept rates on hold and the pace and scale of the asset purchase program unchanged in line with market’s consensus expectation. The BoE did concede that the economy may not return to pre-pandemic levels until the end of 2021. The issue of negative nominal yields as part of the BoE’s toolkit was sidelined encouraging a positive momentum behind the Pound this morning.
Discussion and Analysis by Charles Porter