“Goldilocks” – it’s not necessarily a “new” entrant into the financial lexicon, but like “FOMO” and “BTFD”, it owes some of its ubiquity to the post-crisis dynamic.
The two pillars of the vaunted “Goldilocks” macro backdrop are 1) reasonably robust growth and 2) subdued inflation.
Arguably, you don’t want blockbuster growth, because that could tip the scales in favor of monetary tightening. In the same vein, you certainly don’t want scorching hot inflation, because that would prompt market participants to price in dramatically tighter policy.
On the other hand, you don’t want a recession either, and you definitely don’t want to find yourself in a deflationary spiral.
In short: You want growth to be good enough to justify a rosy take on the global economy, with inflation that’s just below target in order to ensure that central banks are forced to persist in an accommodative lean. You want things to be “just right” – hence, “Goldilocks”.
About the worst thing that can happen to upset this delicate balance (well, outside of runaway inflation, of course) is for central banks to tighten into a slowing global economy, as that increases the chances of deflation.
But that’s exactly what happened in 2018, and it’s important to note that the primary reason why it happened relates directly to Donald Trump’s economic policies. On the home front, he attempted to deliberately overheat the domestic economy by piling fiscal stimulus atop a late-cycle dynamic. That forced the Fed to lean more hawkish than they otherwise might. He then launched a trade war, which undercut global growth and inflation. Fed tightening made things worse for the rest of the world. By the time it was all said and done, USD “cash” outperformed some 90% of global assets in 2018.
Fast forward to 2019, and the Fed, content that Trump’s fiscal policies weren’t likely to spark an unhealthy bout of inflation in the US, and understanding that headwinds to global growth were likely to persist, pivoted. That freed up other central banks to ease, and even if the environment was far from “Goldilocks” (growth was not any semblance of robust outside the US), the absence of an outright global recession and confidence in central banks’ capacity to avert one, combined to create fertile ground for an “everything rally”. Equities were boosted by stimulus hopes, bonds were supported by the very same macro conditions that made more stimulus necessary in the first place, and all assets benefited from the promise of abundant liquidity, which truly is the rising tide that lifts all boats.
Note the incredible turnaround from 2018 to 2019 in terms of the percentage of global assets posting positive returns.
Headed into 2020, it looked as though “Goldilocks” was about to take the wheel in earnest. Optimism around the Sino-US trade pact and the assumption that 2019’s coordinated global easing would soon manifest in better economic outcomes, drove a resurgence in reflation trades in Q4. At the same time, the Fed made sure to emphasize that inflation would have to surge dramatically and sustain that surge in order to put rate hikes back on the table. Abroad, there is virtually no chance of aggressive hiking.
The conditions are in place for “Goldilocks” to make “her” triumphant return. (Famous last words? Maybe.)
Consumer prices in the US rose less than expected last month, underscoring the case for Fed patience and ensuring the bar for rate hikes remains impossibly high, at least in the near-term.
Although the headline CPI print for December (2.3%) represented the biggest increase since October of 2018, it was still cooler than the expected 2.4% gain. MoM, the rise was 0.2%. That too was less than expected. Core is in park at 2.3%.
Going back nearly a quarter century, the current range bodes well – at least in terms of suppressed volatility in equities. “Historically, US equity volatility (6M realized) has been the lowest when US CPI growth has been in a range of 2-3%”, SocGen wrote this month.
Not surprisingly, things get dicey at the extremes on both ends – neither disinflation nor rapid price increases are good news, and generally stoke volatility in equities.
A snapshot of monthly VIX closes and YoY CPI paints a similar (albeit convoluted) picture.
But, as noted above, you need more than subdued inflation. You also need some plausible narrative for why global growth will be reasonably (but not overly) robust.
If you’re not buying into the notion that a lagged response from DM central bank easing is going to do the trick, then you might point to the Chinese credit impulse. “We argued [last month] that the Chinese credit impulse has been one of the main sources of global reflation in the last 10 years, and the current data suggest that we are in the midst of another global reflationary upturn”, SocGen wrote, in the same note cited above.
While the likes of Barclays (and plenty of others) have variously warned that the scope of the inflection in China’s credit impulse is likely to be far less dramatic this time around than during previous efforts on Beijing’s part to reflate, Chinese policymakers may yet succeed in rescuing the global cycle one more time. That would tend to put downward pressure on equity volatility.
Ultimately, the first three weeks of 2020 have been underwhelming in terms of a continuation to Q4’s reflationary optimism, but the ingredients are in place for a modest inflection higher in global growth.
Assuming inflation remains anchored – and there’s every reason to believe it will – “Goldilocks” could be in the driver’s seat in 2020.
Fingers crossed on her as a chauffeur. It’s usually a smooth ride.