T. Rowe Price’s Dillon On Regime Change

Chris Dillon, CFA, Investment Specialist, Global Fixed Income, T. Rowe Price, joined Keith Black, Managing Director of RIA Channel, to discuss regime change.

Dillon notes that a regime change is currently taking place.  In an extraordinary turn of events, there was little geopolitical stress over the last 30 to 40 years.  In 1991, the Cold War ended with the disintegration of the Soviet Union.  The World Trade Organization expanded, with China joining in 2001 and Russia joining in 2011.  Cheaper imported goods flowed into the US, which increased capital formation in emerging markets. With low interest rates post-GFC, there was an abundance of liquidity.  Corporations globalized, outsourced supply chains and increased ROI.  Much of the proceeds from this peak period of globalization flowed into US Treasuries, keeping rates low.  Since 2009, the S&P 500 earned 16% annualized returns. 

It appears, though, that this regime ended in December 2019 with the emergence of COVID-19.  With broken supply chains, globalization and outsourcing turned into onshoring, nearshoring, and friendshoring.  While this derisked corporate supply chains, the disruptions and likely higher labor costs increased inflation.  Geopolitical risks increased from the Russia-Ukraine war and more recent tensions in the Middle East.  These conflicts create risks in European energy prices and disruptions for shipping goods into Europe. 

As the economy was recovering from these massive disruptions and changes in supply chains, the US Federal Reserve Bank increased interest rates by 500 basis points in one year, an unprecedented speed for tightening monetary policy.  While such restrictive monetary policy would have normally slowed the economy quickly, fiscal and industrial policies have been stimulative, working against the Fed’s tightening moves.   

With consumer stimulus during the COVID lockdowns and the 2022 passage of the CHIPS Act and the Inflation Reduction Act, government budget deficits have continued at high levels.  The issuance of new Treasury debt continues to grow each year, with deficits now $2 trillion.  Before and during the GFC, excessive leverage was on corporate balance sheets.  Since the post-GFC bailouts, corporate fundamentals have strengthened while the government balance sheet has weakened.  Today’s situation is the opposite of the GFC, as corporate fundamentals are strong while government finances continue to weaken. 

Resources:

Conditions Are Ripe for a Goldilocks Economy