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What the G-20 Call for More Fiscal Emphasis Means for Investors

Shift toward fiscal policy may boost banks and steepen curves.

The Group of 20 meeting in China added to the chorus of voices calling for more fiscal measures to boost growth, which could have important implications for asset prices if carried out successfully.

With markets accustomed to a world of ever more innovative monetary policy, analysts from Deutsche Bank to Morgan Stanley say such a shift could in time lead to higher yields and steeper curves, and support bank stocks.

Japan looks set to launch a large spending plan in weeks ahead, though it may be months before there’s more clarity on U.K. or U.S. plans. Meanwhile, the ECB’s latest call for euro-area governments to do more looks set to fall on deaf ears.

What's the latest?

G-20 finance ministers said monetary policy alone cannot lead to balanced growth and “fiscal strategies are equally important to support our common growth objectives,” in a statement on Sunday.

Japan is said to be discussing a 3 trillion yen spending increase for 2016. Finance ministry officials briefed Prime Minister Shinzo Abe that stimulus can be increased to 20 trillion to 30 trillion yen, Japanese newspaper Nikkei reports.

Bank of America Merrill Lynch analyst David Woo says Japan is going to lead the rest of developed economies -- if it can find a way out, it will have a huge bearing on everybody else, especially when it comes to the effectiveness of further easing.

U.K. Chancellor Philip Hammond says the government could reset fiscal policy if deemed necessary in the Autumn Statement.

ECB President Mario Draghi said that to reap full benefits from monetary policy, other policy areas must contribute much more decisively, both at a national and European level.

The Bank of America Merrill Lynch fund manager survey shows a record net 44 percent of investors think global fiscal policy is too restrictive.

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What's next?

August: Japan may unveil its stimulus measures at the start of the month. Goldman Sachs analysts say Abe may want to pursue a fiscal and monetary policy mix to supplement one another and elicit a strong market response, but add that more Bank of Japan easing is uncertain.

November 11: U.S. presidential elections due. Both Donald Trump and Hillary Clinton have suggested they will step up infrastructure spending, though much will depend on the votes for the House and the Senate as a divided government may create more obstacles to a policy shift.

November/December: U.K.’s Autumn Statement

What does it mean for investors?

A shift toward fiscal stimulus would suggest an increase in the supply of government bonds, which would lift yields and steepen curves, Morgan Stanley analyst Andrew Sheets says. Such a move would be quite supportive for banks and should drive a rotation within equity markets, he adds.

Bank of America Merrill Lynch’s Woo says we could see easier fiscal policy in the U.S. if one party gets a clean sweep in Presidential vote and both houses of Congress. Unless that happens, Woo remains concerned over the effectiveness of further easing more generally and doesn’t expect the latest rally in risk and cyclical assets to have legs.

The U.K. credit rating downgrade and the pound’s fall could limit Britain’s ability to ease as market will determine how much it can do, Woo says.

Gilts are likely to underperform other sovereign markets, especially European government bonds, on a 12 to 24 month view as easier U.K. fiscal policy would mean a bigger supply of gilts and possibly an acceleration of growth, Woo adds.

The outlook for core European government bond yields looks increasingly asymmetric to the upside, and the rate complex could become more volatile, BlueBay’s Russel Matthews says. Growing expectation that fiscal policy will be the new channel for stimulating growth and inflation is an important factor in that, he adds.

UBS private banking’s Bill O’Neill says the U.K.’s policy emphasis will shift toward fiscal measures over the next 12 to 18 months. While there would be more gilt issuance, there’s huge market appetite, though it does provide a floor for yields around current levels, O’Neill says.

Deutsche Bank strategists including Francis Yared say the strategic case for higher rates rests on fiscal policy potentially taking some burden off monetary policy in the medium term.

RBS analysts including Giles Gale agree that fiscal chat, which has power to affect the current bullish, flattening outlook for bonds, is starting to rise. RBS recommends moving into 50-year Spanish debt versus 30-year U.S. Treasuries to hedge these increasing risks.

Barclays says there could be looser U.S. fiscal policy after the elections and deficits could widen as a result, which could lead to spread tightening at the long end. Meanwhile, we may see some reversal of the steepening in the Japanese government bond curve.