The post-COVID-19 economy: Joseph Stiglitz in conversation with AXA IM

Nobel prize winning economist Professor Joseph Stiglitz joined some of AXA IM’s senior investment professionals to discuss the post-COVID-19 outlook for the economy, financial markets, and the green recovery.

Chris Iggo, CIO Core Investments, AXA IM: Looking ahead, given the big increase in government debt, are we looking at a long period where central banks keep interest rates very low?

Joseph Stiglitz: Yes, I believe that monetary policy won’t be able to be used very much as a stabilisation mechanism, and instead countries will rely on fiscal policy for macro stability.

Nick Hayes, Head of Total Return & Fixed Income Asset Allocation, AXA IM: As interest rates remain low for longer, this has an impact on government bonds - yields are very low, and that won’t change in the short-to-medium term. The key element is acknowledging their role in the portfolio, to potentially defend against volatility and widening of credit spreads by creating diversification away from high-yield spreads and risk asset volatility.

Chris Iggo: Are investors losing some confidence in central banks after the Fed’s recent shift towards an average inflation target of 2%, and because rates are low - does this explain why gold is rising in price?

Joseph Stiglitz: People always turn to gold when they think there is going to be inflation, but I don’t see inflation any time soon. Inflation is when you have excess demand for goods - right now we have excess supply. There are shortages in parts of the US of particular goods, but overall, goods are in excess supply.

The focus of the Federal Reserve in moving to an average inflation target is an attempt to do what they used to call forward guidance - another way of telling the market we will keep interest rates low for a long time. But there is little evidence that markets pay much attention to forward guidance.

In my mind the real problem is not the interest rates but the availability of credit and the willingness of the financial system to lend, and that will be circumscribed as long as the magnitude of the financial uncertainties we are facing today remain.

The commitment of the fiscal authorities to keep spending going is more important than commitment of monetary authorities to keep rates low. I would like fiscal authorities to do what [former President of the European Central Bank] Mario Draghi did in Europe in 2012 and say they will do “whatever it takes” - that will be key to a strong recovery.

Chris Iggo: If governments are going to spend more on carbon transition where would you like to see that money spent?

Amanda O’Toole, Clean Economy strategy manager, AXA IM: Energy transition is clearly already underway. From a government perspective, renewable energy is the most economic form of generation capacity to build, and from a corporate perspective it is increasingly important to be seen to be adopting clean tech. There is already a huge demand even without seeing additional policy support.

Where governments need to offer more support is around clearing up the practicalities. We have seen issues where there is demand for a clean project, it works on an economic basis, the tech exists, but bureaucracy can be quite slow.

I would also like to see governments supporting investment in the infrastructure around renewables and electric vehicles. We have hit a point where we need a smarter grid that can manage the volatility of renewables, more storage capacity, new grid connections and better support in terms of electric vehicle infrastructure such as charging networks.

Then I would also hope to see more support for piloting new technology. The clean tech sector has made huge leaps over the past 10 years but there are still areas where we can go a lot further - for instance around hydrogen testing where we would like to see more research and development.

Joseph Stiglitz: The carbon transition should consist of the use of a comprehensive package including regulations, public investment and incentives through carbon pricing, and I don’t think it will generate any significant inflation. In fact, I believe the time to introduce carbon pricing is now, as it could offset deflationary pressures.

I do want to highlight a few aspects of the green transition: First, it is going to be comprehensive, across energy, transport, housing, commercial real estate, food production and agriculture and more.

Second, there needs to be commitments to long term-investment. And third, it is also about making access to funds available to small and medium-sized businesses and households, for instance for installing installation or solar panels. It is important for Europe to be investing more in that kind of science and technology.

Chris Iggo: There is considerable investor appetite for ESG-related assets, and green bonds particularly have proved to be important vehicle for raising finance. How do you see that market evolving?

Nick Hayes:  We have seen huge growth in the green bond market over the past five years, and we see that continuing. There are a number of different initiatives that will start to evolve, such as so-called blue bonds which have a water focus, and companies being encouraged to be more transparent about what the proceeds will be used for. As lenders and guardians of our clients’ money there is a growing emphasis on us to make sure we are appropriately deploying capital – it is a huge focus for us internally but also across the industry.

Chris Iggo: Are you optimistic that Europe is on a path to greater unification or will we see a recurrence of structural tensions?

Joseph Stiglitz: The €750bn European recovery fund bond issue was a big achievement. I wish more had been in the form of grants, but the fact that they agreed to have a significant fraction of grants was a move in the right direction, so I’m hopeful. The fact that it was a difficult fight is the nature of politics - in the end they compromised.

Regarding green bonds, one concern investors and central banks should have is stranded assets. The globe is moving towards a green economy and the evidence is overwhelming that assets in coal, even oil and to some extent in gas will wind up as stranded assets of very low value. We have more fossil fuel than we know what to do with. The world has changed very dramatically, and these are viewed now as assets with a high level of associated risk.

Amanda O’Toole: We no longer really have a discussion about a trade-off between environmental benefits and positive returns, as the technologies that are best positioned to improve us from an environmental standpoint seem those most likely to win in terms of market share and growth. Regarding fossil fuels, to my mind that part of the market is structurally challenged and there are stranded asset risks, and a question mark over the extent to which reserves are economic, what cash flow might be from them.

Chris Iggo: What is your investment outlook for the rest of this year and going into 2021?

Amanda O’Toole: In terms of the Clean Economy strategy I manage, longer term growth opportunities in this space are well underpinned. We saw in first wave of the pandemic a commitment to capex in this space which has been very reassuring. I would expect clean tech fundamentals to remain constructive and for the long-term outlook to remain positive.

Nick Hayes: Overall 2020 has been pretty challenging, but it’s not over yet - we expect more volatility and are building portfolios strategies that are positioned for that. We are focusing on a combination of high- quality government bonds - but you can’t make money out of high-quality government bonds alone, so we are going into US and Asian high yield where we see some value, though not without taking credit risk. We are also looking for some sort of hedge against volatility such as via cash or credit default swaps. Diversification is key for managing assets through next three, six and maybe 18 months.