3. The economics of protracted low growth are becoming more unpredictable.
Yet another set of unfavorable, though relatively small, revisions to the International Monetary Fund’s global economic projections are a reminder of the persistence of subdued growth in the advanced world and its negative spillover onto other countries.
The working assumption among most economists is that this mediocre performance can persist for years in a relatively stable fashion. I am not sure that prediction is correct because the longer this “new normal” persists -- and it has been with us for about seven years -- the more it seems to be creating the causes of its own destruction.
One of the big economic risks here is that households will join companies in becoming more cautious and will postpone some consumption decisions. Should this occur, it would contribute to an even bigger gap between subdued economic risk-taking and high financial market risk-taking -- this would add an element of financial instability that the global economy has essentially been spared from for a few years.
These developments suggest greater market volatility in the final quarter of the year. The most sensitive segment will be foreign exchange, especially given the unusual economic and political uncertainties affecting trading relationships that have been deeply ingrained in economic and financial structures. This is also the market segment that, at least in relative terms, is least sensitive to central bank volatility suppression.
But what starts in foreign exchange is likely to spread to equities, commodities, corporate bonds and, to a lesser extent, government bonds.
After enjoying a calm summer, markets should brace for greater volatility in the final quarter. Investors would be well advised to incorporate higher uncertainty risk premiums in their investment calculations, and favor lower volatility portfolio positioning and higher cash balances. By doing so, they can better prepare better for a skewed risk-return market proposition.
Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco.
This column was provided by Bloomberg News.