So, if the U.S. was to embark on a fiscal easing phase on its own, stronger domestic demand and in turn demand for imports would likely widen the country’s external deficit again, and worsen global current account imbalances. This would have several possible consequences:
• Fuel an increase in protectionism, and in turn lead to more global political risk.
• Lead to a less balanced global economy, where final demand engines are more concentrated. Capital flight risk could rise in the most levered economies, perhaps causing sudden stops in financing. Under this scenario, we could also not rule out risks of economic overheating, asset price bubbles and eventually significantly higher interest rates in these economies.
This is why we believe that a broad-based global fiscal expansion, rather than one led by a single country running an external deficit, would be preferable.
Investment Conclusions
As we argue in our Secular Outlook, remain positioned for a continuation of the L-shaped New Normal environment for the next few years, while exercising special caution given possible disruptions, including populism and a slowdown in China, among others.
These disruptive forces mean that a regime shift towards aggressive fiscal easing is more likely as time goes by, as governments seek to counter global economic challenges. We will closely monitor political developments in this regard, and be ready to adapt our strategies to a new scenario with higher growth, inflation and interest rates, were policy makers globally to turn on the fiscal taps.
Nicola Mai is a portfolio manager and a sovereign credit analyst for PIMCO. Peder Beck-Friis is a portfolio manager for PIMCO.