Economists Scott Baker, Nicholas Bloom, and Steven Davis built the economic policy uncertainty index. Inputs to the model include “frequency of news media references to economic policy uncertainty, the number of federal tax code provisions set to expire in future years, and the extent of forecaster disagreement over future inflation and federal government purchases.”
As you can imagine, the index has been registering pretty elevated levels as of late (the higher the index, the more uncertainty there is).
In a note to clients, Morgan Stanley economist Gerard Minack highlights the correlation between the policy uncertainty index and 10-year bond yields (in this chart, he is averaging the value of 10-year Bunds and Treasuries):
Photo: Morgan Stanley
Given the correlation shown above and the dismal outlook for policy action, Minack thinks lower valuations on risky assets like stocks are here to stay for a while:
Finally, the outlook for fiscal policy and public sector finances is a major uncertainty for investors. It is part of the reason why risky assets are being de-rated and ‘safe’ assets are at unprecedented valuations. Exhibit 6 shows an index of policy uncertainty and the average US Treasury and German bund 10 year yields (inverted in the chart, so the line goes up as the yield falls). Yields have fallen as uncertainty has risen. To the extent that uncertainty about fiscal policy persists – and this seems set to be a structural risk – it reinforces our view that in future the valuation on risk assets will be structurally lower than the average of the past 20-30 years.
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