When the pandemic spread around the globe in February and into March, among the immediate impacts was a sharp spike in the level of uncertainty around the world. Here and in other nations, policy plans were thrown in the bin and people’s expectations of what the next few years would look like were blown to smithereens.
We saw carnage on the stock market one day, recovery the next, then even carnage in the morning, recovery in the afternoon. No one had any real idea what was going on; uncertainty reigned supreme.
Well now at last some good news – we are no longer uncertain; the bad news is we’re certain things are stuffed.
The economic policy uncertainty index for the United States remains well above any levels seen this century. But that reflects the coming presidential election and the complete failure by Donald Trump to provide anything like a competent response to the economic and health crises.
In Australia, however, while the pandemic in March saw the level of uncertainty reach the levels observed during the GFC, the debate over the carbon price in 2011, and the respective dumpings of Kevin Rudd and Malcolm Turnbull, now it is moving back to somewhat calmer levels:
This restoration of calm is also occurring in the stock market. A good indicator of uncertainty is the gap between the lowest and the highest daily level of the ASX200 index. If investors are relatively certain about where the market is heading there is little difference.
The long-term median difference between the daily low and high point of the stock market is around 0.8%, and yet during the pandemonium of early March there were 23 trading days in a row where the difference was greater than 3.5%:
No one had a damn clue. On 13 March, the stock market fell 8.1% early in the day before ending the day up 4%. The next day it fell 10%.
Madness. You might as well have taken your money to a casino (were any open).
Over the past couple of months however, things have settled down. We’re still not back to the calm old days of yore (ie six months ago) but rather than seeing such extreme fluctuations of 10%-12%, now the market on average moves around 1.4% from low to high on any given day.
We have also seen calm return to the bond market.
Partly this is because the Reserve Bank has instituted the calm by targeting a yield of 0.25% for Australian government three year bonds. But calm and certainty is also observed with other bonds, even in the face of ever increasing budget deficits.
When the pandemic hit and the government and RBA were formulating a response we saw yield for government bonds plummet – within a month going from 1% for 10-year bonds to 0.6%. And then in a week in March it surged to 1.50% as investors went from being spooked about a worldwide recession to news of massive stimulus and debt levels:
But since the middle of April when investors essentially worked out that the soaring debt levels were not going to mean the end of the financial world, and that for the most part ratings agencies were going to shift the dial on what were acceptable levels of debt by a few dozen billion, things have settled down.
Again this is also because the RBA very much has its thumb on the scale desperately trying to assure everyone that these low interests rates will continue for years to come – at the very least till 2023.
But just because there is more certainty in the world, that does not mean things are improving. Rather there appears to be merely a growing comfort with the reality that dark economic times are here to stay.
The spread between the Australian government five-year and two-year bond yields has historically been a good indicator of future economic performance. When the five-year bond yield falls below the two-year rate (what is known as a negative yield curve) that is a good sign a recession is one the way.
Now clearly we are in a recession but the signs of a recovery remain yet to be observed. The gap between the yields is currently positive, but unlike, for example, during the GFC, there has been no surge that might suggest good times are to come in three to five years:
And we see this as well with the outlook for inflation that is gauged by comparing the spread between the Australian government 10-year bond yield and the “indexed bond yield”. In the past this has been a very strong indicator for future inflation growth. In March this measure plunged to at times below zero – indicting future deflation.
And while it has now stabilised somewhat, it has done so at an historically low level:
There is little sign of an increase in demand that might cause inflation growth to increase at let alone back to normal levels of 2% or more.
And so when we look around at various economic and financial indicators we do see a shift from the hectic and crazed times of the March and April. That is good news. But the bad news is the shift has not been to one of optimism, but rather acceptance of dark times ahead.