Chart of the week: Economic uncertainty

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It’s an old and tired cliché, but markets really don’t like uncertainty.

The Global Economic Uncertainty Index, which combs newspaper articles to detect levels of policy uncertainty, has had a pretty good relationship with global equity market performance over the last two decades. In recent years, the index has experienced wild swings as investors attempt to analyse an evolving geopolitical landscape and dramatic changes in the implementation of monetary policy. It isn’t only financial markets that are attempting to get to grips with the economic outlook - businesses and households make decisions about investment and spending on a daily basis. As a recession narrative grows in-line with economic uncertainty, it is natural that business and households become less optimistic about the outlook and tighten their belts. Recession becomes a self-fulfilling prophecy as the decline in consumption and investment leads to declining economic growth and lower equity market returns. The inverse is also true: falling economic uncertainty is associated with higher equity market returns, as our perceived certainty around the economic outlook improves.

Looking ahead, there’s been increasing talk of a global recession but we don’t see an imminent risk of such an event. One of the main positive drivers is the dramatic easing of global monetary conditions. After tightening last year, developed market yields have plunged by a similar magnitude to 2007-2009. The Fed is again buying bonds and cutting rates more than it anticipated, the ECB launched a broad-based easing programme, and the Reserve Bank of Australia has cut interest rates to a record low. In addition, almost every major EM central bank is lowering rates, many after a painful tightening last year. This is a potent mix that will likely support the global and Australian economy going into 2020.