(BFM Bourse) – This principle has come back insistently in recent weeks to describe an economy where central banks manage to bring inflation under control without penalizing activity too heavily. While this ideal scenario may have allowed the market to climb recently, it is nonetheless hypothetical and fragile.
The world of the stock market and economics generally likes simple ideas inspired by myths or pictorial concepts. An example is the “black swan” theory, which refers to a threat that is supposed to be improbable until it materializes. The great financial crisis of 2008 can therefore be considered a black swan.
In the same vein, a term has come up with insistence in recent weeks, namely the “Goldilocks scenario”, which refers to the famous tale “Goldilocks and the Three Bears”.
As often with these ancient stories, different versions exist. But in the best known, the one that interests us, a young girl with blond hair (hence the name “Goldilocks”) enters a house inhabited by a family of three bears (the father, the mother and the ourson) who are absent. She will then taste the three bowls of porridge, preferring that of the teddy bear, neither too hot like that of the father, nor too cold like that of the mother. Same thing for the bed: she still prefers that of the teddy bear, neither too hard like the father’s nor too soft like the mother’s bed.
This story illustrates the dialectical process (thesis, antithesis, synthesis) and especially gave birth to the “goldilocks principle”, or the “Goldilocks principle” which evokes the zone of optimal balance. This principle is found in many fields, whether it is psychology – children would like to pay attention to events that are neither too simplistic nor too complex, according to this principle – medicine, astrobiology or even communication.
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Optimal economy
In economics, the “Goldilocks” principle describes a situation where growth reaches a modest but real pace, without creating excessive inflation. In other words, activity is neither overheating nor in a slowdown phase that would suggest a recession threatening employment. This is reminiscent of economist Nicholas Kaldor’s “magic square”, where the economy is growing, inflation is under control, unemployment remains low, and the current account balance is positive.
This “Goldilocks” scenario has therefore recently returned to market commentary to evoke a certain optimism in the light of several indicators, in particular the latest US employment report, at the beginning of August, as noted by Stephen Innes of Spi Asset Management.
The market thus wanted to believe in the idea that the central banks and especially the American Federal Reserve (Fed) would succeed in bringing inflation back to the level of 2% within an acceptable horizon without needing to press the pedal of the restrictive monetary policy, thus allowing the economy to avoid an economic contraction.
“The ‘Goldilocks’ scenario of lower inflation, slow growth (but no recession) and no further interest rate hikes has driven risk assets higher over the past weeks,” Bank of America noted earlier this month.
“The market has fully accepted the scenario it wanted, namely the ‘Goldilocks’ scenario. Until we have data that scares them, it is difficult to see how this will change”, judged from his side at the end of July Bob Kalman, senior portfolio manager at Miramar Capital, quoted by Reuters.
A scenario that requires confirmations
Still, this scenario, however pleasant it may be, is not set in stone. The downgrading of the United States’ credit rating by the rating agency Fitch acted as a wake-up call in the face of excessive optimism.
In a recent FX note, UBS said, “The past four weeks have shown how volatile ‘Goldilocks’ expectations can be for currency investors. the fall in activity data mainly outside the United States, and the rise in oil prices have enabled the American dollar (currency considered as a safe haven and therefore supported by economic uncertainties, editor’s note) to strengthen”, continues the Swiss bank.
Concerns about the Chinese economy and the rise in bond yields have also weighed on the markets and reduced investor optimism in recent days.
“We … caution against complacency. Markets expect ‘Goldilocks’ economy as Fed staff and consensus predict no more recession, inflation set to decline rapidly over the coming year and the consensus on earnings forecasting strong increases (in the range of 10% in the United States) in 2024 and 2025. However, the road to this perfection is narrow”, recently warned the Generali Insurance asset management teams, led by Vincent Chaigneau.
“If exorbitant inflation rates seem behind us, the home stretch to reach the 2% target could prove the most difficult (…) Our basic assumption remains that the brutal monetary tightening of the United States States over the past 16 months will lead to a moderate recession by the end of 2023 or the beginning of 2024. At the same time, the euro area, which has already experienced a technical recession, will only slowly escape stagnation, in a context slower credit expansion and tighter lending standards,” they said.
Further progress will therefore be needed for this ‘Goldilocks’ scenario to gain credibility. “The ‘Goldilocks’ scenario will need favorable statistics and the absence of negative surprises in order to keep the ‘bears’ (investors who bet on a market decline, editor’s note) at bay”, concludes Barclays bank in a note published last week.
Julien Marion – ©2023 BFM Bourse