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Modern economic growth and policy have been fueled in large part by a shared vision of global order and cooperation, with an end goal of achieving positive outcomes that can benefit all participants — the “globalization” theme that has dominated macroeconomic discussions for the past generation.
Recently, however, globalization has begun to backpedal amid rising populism and a renewed emphasis on global competition over cooperation. Government policies are now increasingly influenced by the concept of a “zero-sum” game: To win, somebody else has to lose. Accordingly, policymakers worldwide are intent on ensuring that their nations’ economies and populations are not left behind.
While “deglobalization” will take time, the COVID-19 pandemic has helped put the world on a faster track to a less synchronized global economy. Ultimately, this should lead to meaningful disruptions, disparities, and divergences globally and, in turn, to potentially compelling investment opportunities. We believe active management, rooted in deep analysis of relative value across countries and sectors, is best suited to navigate this dynamic environment.
Deglobalization is slowing global trade
Some early results of deglobalization are apparent in the plateauing levels of global trade activity over the past dozen or so years. As shown in Figure 1, global trade as a percentage of the world’s gross domestic product (GDP) has not really grown at all since the peak it reached just prior to the 2008 global financial crisis.
Recent trade policy steps taken by the US and China have not only grabbed headlines, but have also served to further restrain global trade. Indeed, former President Trump even went so far as to frame US-China trade frictions in the context of a “zero-sum” world. The degree to which those tensions might ease with President Biden now in office remains to be seen, but in any case, slowing trade is a global phenomenon and symptomatic of a broader paradigm shift — one we believe is likely to persist.
Deglobalization (like globalization before it) will of course be a multiyear process, but its implications can accrue swiftly and have recently been accelerated by the widely varying individual country responses to COVID-19. Potential near-term implications of deglobalization include:
- The return of volatility: Over the past 10+ years, powerful government support in the form of ultralow policy rates and massive quantitative easing (QE) has dampened asset-price volatility globally. While front-end rates are likely to remain low for the foreseeable future, we do not expect volatility to stay suppressed, especially in currencies and long-term rates.
- Credit spread widening: Fixed income credit spreads and many bond prices may come under mounting pressure in the period ahead, as emerging market economies and their smaller developed market counterparts are more or less left to “fend for themselves” in an increasingly isolated global economy.
- Dispersions in sovereign interest rates: Higher sovereign-debt risk and the prospect of rising inflation on the horizon may create significant dispersions across sovereign-bond interest rates, excluding the front end (which, as noted above, is likely to remain pinned).
- Higher odds of exogenous events impacting economies: A declining commitment to global cooperation may weaken global institutions and alliances, potentially leading to less coordinated (and less effective) reactions to geopolitical and public-health crises.
Investors, who have long been lulled into complacency by accommodative government policy, should be prepared for the new paradigm. The risk-taking that rewarded many investors over the past decade could prove problematic going forward, as strategies that rely heavily on beta and carry may underperform. Many global governments have little or no ammunition left in their stockpiles. As such, any additional support they provide is unlikely to be as plentiful or to have the same “calming” effect on markets. In fact, recent comments by central bankers suggest that QE may be nearing its limits.
Zero sum in practice
Over the past several years, term premiums have been depressed and sovereign risk largely ignored, as monetary policy has been a primary driver of asset prices. However, the need for staggering amounts of fiscal stimulus to combat the COVID-19 crisis is historically significant. With fiscal authorities essentially “co-opting” money printing presses, we believe these risks will loom larger over the next few years. Many countries and regions have benefited greatly from the globalization experienced in recent decades, but those structural tailwinds are clearly in reverse (Figure 2).
Let’s look at the UK as an example. While the country reaped the benefits of globalization for many years, it now faces challenges — but also potentially overlooked opportunities:
- On interest rates, the Bank of England (BOE) has opened the potential for further rate cuts as it looks for ways to combat headwinds from Brexit and deal with restrictive public-health policies in response to the UK’s COVID-19 woes. By contrast, US Federal Reserve (Fed) Chair Jerome Powell has repeatedly said negative rates are not an option that is on the table at this time.
- On sovereign credit, the UK’s yield curve steepened more sharply than other developed market sovereign credits in the second half of 2020, reflecting a toxic mix of economic drag from Brexit, gloomy short-term data, and rising estimates of the government’s borrowing needs. Moody’s recent credit downgrade of UK sovereign debt was in response to these developments. Fiscal-monetary coordination and the BOE’s credibility with regard to its inflation target will influence the UK government’s borrowing cost for the foreseeable future.
- On currency, the British pound is vulnerable in the short term given the UK’s recent exit from the European Union (EU) and related transition risks, plus potential ramifications of the recent resurgence in COVID cases. Looking ahead, though, there may be a valuation floor for the sterling, as ongoing trends toward localization and deglobalization should play well to the UK’s history of economic vibrancy and technological leadership.
Active management is key
As the deglobalization narrative continues to unfold and a “zero-sum” world begins to come into focus, we believe nimble active management will be key to helping investors manage risks and capture opportunities across interest rates, currencies, and credit differentiation.