Economic Policy: A Double-Edged Sword

A significant structural tightening in fiscal policy, at around 5% of GDP, reflects a transition to more expansionary fiscal measures compared to previous deflationary strategies that featured tight fiscal policies alongside ineffective monetary tools like quantitative easing and negative interest rates. While governments are increasingly turning to fiscal solutions in response to crises, such as geopolitical instability or inflation, this shift suggests that current fiscal policies could drive economic growth and inflation higher rather than precipitating a debt crisis. The previously stable correlation between bonds and equities is changing due to increased supply shocks, resulting in counter-cyclical inflation that diminishes the portfolio insurance properties of bonds, thus widening the term premium. This evolving economic landscape marks a departure from prior conditions where inflation was solely demand-driven.