Addicted to the medicine

It comes as a relief to markets that G20 officials have agreed it is too early to begin withdrawing massive fiscal, monetary and financial support.   However, it is hardly surprising that officials are not formulating an early exit from emergency measures especially given the ongoing uncertainty about the pace and shape of global economic recovery.  

The latest US jobs report did not help clarify the outlook for markets as a smaller than forecast drop in employment in August (-216k) weighed against a surprise jump in the unemployment rate to a 26-year high of 9.7% and downward revisions to past months employment data.

There is a growing possibility that the Fed’s expectation the unemployment rate will breach 10% by the end of the year looks may be hit even earlier.  Fears about a “jobless recovery” will likely increase as a lack of hiring is set to persist for some time yet. 

The absence of any near term reversal of stimulus measures reduces the risk of a “double dip” recession but at some point there has to be a reckoning. Fiscal positions have blown out for many countries and will eventually require spending cuts, higher taxes and/or privatisation in addition to likely increases in the retirement ages for workers, to rectify them. It is questionable how sustainable recovery will be once such measures begin to be implemented.

In the meantime, it is not even evident that policy is working efficiently. Arguably yields on bonds and corporate debt are lower than they would otherwise have been had it not been for central bank actions but lenders are still not passing the additional liquidity to consumers and households against the background of fears about a rising tide of bad loans and delinquencies.

I would compare this to a patient who came close to death and has finally come off life support as the worst passed but has relied on support in the form of various strong medicines to keep him (or her) going.  The risk that the patient has become overly dependent on the drugs has grown but it is highly unclear how he will fare once he is weaned off.  

Fears about the ability of the patient to stand on his own two feet will increase.  The risk that the patient will relapse is intensifying but his ability to pay for more medicine is already diminishing and his options are running out quickly.

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