Which assets will benefit if policy flips from monetary to fiscal stimulus?


Bond substitutes and growth stocks could lose out if policy shifts from monetary to fiscal stimulus, says the Bank of America Merrill Lynch, while banks, inflation-protected securities and value could be the winners from such moves.

“We are convinced that the flip from monetary to fiscal policy will drive asset allocation and asset prices in coming quarters,” the bank says in its latest global investment strategy report as it anticipates success from a rotation into “inflation” assets from “deflation” assets.

It expects the policy baton to pass between monetary and fiscal stimulus between 2016 and 2017 as governments seek to stem the rising electoral success of populists, as seen in the Brexit vote and now the US election.

While markets are almost certain the Bank of England will cut rates at this week’s monetary policy committee meeting, the Bank of Japan and the ECB have both voiced reluctance to take interest rates further into negative territory.

Today the Japanese government approved 13.5trn yen ($130bn) for fiscal stimulus, while ECB president Mario Draghi has urged European governments not to rely on monetary policy. Last month the central bank cancelled Spanish and Portuguese fiscal rule-breach fines, representing a more permissive stance.

While the UK is likely to buck the trend when it comes to monetary easing, the government has indicated support for fiscal stimulus.

In the US, both presidential candidates have voiced support for infrastructure spending. Markets are currently pricing in a 45 per cent chance of interest rates rising before the end of the year.

The flip to fiscal stimulus could take form in redistributive, Keynesian or protectionist policies, with the former two likely to be the most dominant, BAML says.

Redistributive policies, which include minimum wage rises and taxing the wealthy, will have a stagflationary effect and favour treasury inflation protected securities, municipal bonds and low-end consumption stocks. In contrast, luxury stocks and growth will lose out, according to BAML.

Keynesian policies, which include helicopter money, have a reflationary impact and favour TIPS, commodities, banks and value, while hitting bond substitutes. Other policies can include infrastructure spending and tax rebates, as well as living wages.

Protectionist policies would tend to have a deflationary impact and can include increased trade tariffs, reducing the free movement of people and adopting more isolationist foreign policies. The winners in this case would be gold, government bonds, and high quality defensive stocks. Losers would be banks and multinational companies, BAML says.

Former Monetary Policy Committee member Kate Barker this week warned that interest rate cuts would hit the economy harming bank profits, weaken the pound and deter household spending.