With Election Results All But Decided, Additional Fiscal Stimulus Remains Uncertain

November 6, 2020
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Democrat and former Senator and Vice President Joe Biden looks as if he has the advantage in reaching the 270 Electoral College votes required to become the next President of the United States. But his party fell far short of expectations in the Senate, where Republicans will retain majority control (at least possibly until January) and lost seats in the House of Representatives, making their majority there narrower. This outcome will likely lead to less spending on pandemic relief and infrastructure projects than a Democratic takeover of the upper chamber would have resulted in, which pre-election polls had suggested was a strong possibility. Democrats alone will not be able to unilaterally decide on and pass legislation to send money out to unemployed Americans, closed and struggling small businesses, and strapped state and local governments. Compromise and continued support by the Federal Reserve will be required to help boost a reviving, but still very fragile, economy.

For the past few weeks, investors dared to dream of a U.S. government all working together to provide ample fiscal aid and get the world’s largest economy through the coronavirus pandemic sooner rather than later. Investors positioned for a Democratic sweep anticipating not only trillions of dollars in additional coronavirus relief but also more spending on renewable energy and infrastructure projects – enough, potentially, to at least increase the threat of higher interest rates and drive the ten-year Treasury yield to 1.00% or higher. The prospects for that result now appears to be faint.

For market participants hoping for more economic stimulus, this election may have produced the worst possible outcome – legislative gridlock instead of any new legislation.

All hope is not lost. Passage of another round of COVID relief remains possible, both before the end of the year and after the January inauguration and Congressional seating. If House Speaker Nancy Pelosi wants to get a Biden administration started on solid footing, she will try to cut a deal with the most powerful remaining Republican in Washington, Senate Majority Leader Mitch McConnell, before Biden is sworn in as President on January 20th.

On the day after his senatorial re-election, McConnell sounded amicable to compromise, even on the thorny issue of large-scale aid to states and cities, saying that “hopefully, the partisan passions that prevented us from doing a rescue package have subsided” and that this will be “job one when we get back.”

It is useful to recall just how stuck negotiations were before the election. Last month, Pelosi and Treasury Secretary Steven Mnuchin were engaged in drawn-out talks over a pandemic relief bill. There was little possibility that anything nearly as large as the two of them were discussing, a spending package in the range of $1.5 to $2.2 trillion, was going to pass the Senate. Even before the election, many Senate Republicans had begun to assert their concern about the rising national debt.

Pelosi and other Democrats assumed that the prospects for any deal would be far better if they controlled the Senate and White House. With that no longer a possibility, Pelosi now has incentive to take whatever deal she can now get. Holding out for a better deal does not come with the guarantee of a bigger package later, but it does risk damaging the economy in the meantime, making it harder for Democrats to govern once Biden is sworn in and setting a weak stage for the 2022 midterm congressional elections.

Any fiscal package now would certainly be much smaller than the one the Trump administration agreed to before the election, despite McConnell’s and the Senate’s pushback. Even a small stimulus package could be enough to stabilize the economy, at least over the next few months through January at which time additional fiscal aid can be revisited.

Despite the Senate’s reluctance to spend, the chamber does support additional immediate funding for schools, health care, and loans to small businesses. McConnell, already stating that a stimulus bill is a priority when the Senate returns next week, is also in a much better position to attain his longstanding goal of business pandemic liability protections in exchange for some tolerable support for state and local governments that Democrats are desperate to pass.

If a deal is not consummated before Biden is sworn in, the difficulty level to do so greatly increases. With Trump gone, the Republican Senate would probably dig in and demand a return to austerity. The situation would call for the type of cross-aisle negotiation Biden has the reputation at excelling at, and he would look to offer Republicans something they want more than a return to fiscal discipline. The obvious trade would be to make Trump’s tax cuts, at least in part, permanent. That would open Biden to the condemnation of surrendering to Republicans just after winning a mandate to overturn their policies. But defending such criticism may be preferable to enduring the pain of a slow, or worse, retreating recovery.

Neither of these scenarios is appealing for Democrats who will lose the luster of at least taking back the White House. But their main concern should be giving the economy the boost it needs immediately and even more next year. For both the country and the Biden presidency, failure here could be devastating.

However the next few months play out, it is hard to imagine Senate Republicans willing to do “whatever it takes” on the fiscal spending side to get the U.S. economy back to its pre-COVID levels, especially if Biden and the Democrats can take credit for the rebound. More likely, much of the burden of further incremental stimulus may very well hinge on the actions of the Federal Reserve.

Fed facing the prospect of shouldering more stimulus responsibility

The prospect of a divided U.S. government dims the chances for robust fiscal stimulus, leaving the Federal Reserve to resort to its old toolkit to further help the economy. Just earlier this week heading into the election with the market’s quick and steep run-up in long-term rates, it looked as if the biggest question for the Fed was whether it would step in to combat an aggressive steepening of the Treasury yield curve, with traders positioning for a large round of fiscal stimulus with the view that Democrats would take not only the White House but the majority in the Senate. The election aftermath, especially with the likely defeat of a “blue wave”, took care of that question with ten-year yields falling 14 basis points on Wednesday from 0.90% to 0.76%, the most since March, while 30-year yields tumbled by roughly the same amount back to 1.54%.

The prolonged presidential election decision and prospects of political gridlock were the backdrop to the Federal Open Market Committee’s (FOMC) decision on Thursday to keep its federal funds target near zero and making no change to its current pace of asset purchases. Fed Chairman Jerome Powell stressed that the economy needs more fiscal and monetary policy support and warned that mounting global coronavirus infection rates are a risk. “I think we’ll have a stronger recovery if we can just get at least some more fiscal support,” Powell told reporters in the post-meeting Q&A session. “The recent rise in new COVID-19 cases, both here in the United States and abroad, is particularly concerning.”

The Fed earlier kept the federal funds target rate in a range of zero to 0.25%, where it has been since March, and maintained bond purchase plans at $120 billion a month. Powell spoke about the outlook for the economy as the results of the U.S. Presidential election remained uncertain.

“Economic activity and employment have continued to recover but remain well below their levels at the beginning of the year,” the FOMC said in a statement following its two-day meeting, largely repeating language on the economy they’ve employed since July. In language identical to their prior statement in September, the FOMC added that “the ongoing public health crisis will continue to weigh on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.” Treasury yields remained little changed after the Fed statements, with the ten-year Treasury yield hovering at about 0.77%. The yield curve steepness, as measured by the gap between the two- and ten-year Treasury yields, along with the spread between the five- and 30-year Treasury yields, also held steady at about 63 basis points (0.63%) and 121 basis points (1.21%), respectively.

While vote counting continues in the closely contested states of Pennsylvania, Georgia, Arizona, and Nevada, it becomes increasingly more obvious that America’s two major parties will split control of Washington. Democrat Joe Biden is on the brink of capturing the White House, and his party will retain the majority in the House of Representatives, albeit a much smaller majority than before the elections. Republicans will maintain majority control of the Senate, but this may be short-lived if not one but potentially two senatorial run-off elections result in Georgia, as seems to be the case. With Democrat victories in both these Georgian run-off elections on January 5th, along with the one net Senate pickup from Tuesday’s election, the Senate would be at an even 50-50 split, once two independents are included in the voting block along with Senate Democrats. With a Biden presential victory, that means that Vice President Kamala Harris will be the deciding vote on any split decision on the Senate floor. Such a series of very possible events would once again re-establish complete congressional and presidential control in Washington by Democrats, at least for the next two years until the next round of House and limited Senate elections. This would also be expected to be a positive boost to the markets that will once again speculate on the probability of expanded fiscal stimulus.

But until such a scenario plays out, the currently split political outcome reduces the chances for a big fiscal stimulus package from Congress during the lame duck session to the January run-off elections, even as the COVID-19 pandemic continues to threaten the economy, with new daily infection records that failed to make news headlines with all the media attention on the election turmoil. That may put more pressure on the Fed to ramp up its bond buying, or at least change the composition of its purchases, to lower borrowing costs in effort to boost the recovery in the meantime.

Powell deflected a question about the election in his Q&A session, noting that it “comes up now and again but it is not at all a central focus of the meeting.” Powell sounded a bit more hopeful by noting that “there are plenty of people on Capitol Hill who see a need for further fiscal action.”

With fiscal support looking both smaller and perhaps less likely, the Fed will have to think harder about what it can do to steer the economy in the desired direction. Fed officials, however, made no change to monthly purchases and gave no signal they might do so when they meet again on December 15th-16th.

The economic recovery remains uneven against a backdrop of surging COVID-19 cases along with more than 12 million Americans still out of work. October’s employment report, reported Friday morning in the wake of all the presidential election upheaval, showed the U.S. jobless rate continuing to edge down to a lower than expected rate of 6.9% with a higher than expected increase in non-farm payrolls of 638,000. Though, the number of long-term jobless Americans surged and now makes up a third of those out of work.

But judging by the reaction across other financial markets, it is clear traders are thinking beyond the votes and betting on the Fed having to shoulder a significantly rising burden of resuscitating the U.S. economy. These investors most likely remember 2011 through 2015, when a Republican-led Tea Party Congress brought the U.S. to the brink of default under President Barack Obama and forced the budget deficit to narrow each year in the name of fiscal responsibility.

From the time of the debt-ceiling showdown in 2011 through the Fed’s first interest-rate increase of the cycle in December 2015, the S&P 500 Index returned 90%, or 15.8% on an annual basis. The 30-year Treasury yield fell from about 4% to 3%, dipping to as low as 2.22% along the way. Corporate bonds delivered strong returns. In other words, it was a prosperous period for major financial assets.

This is the conundrum the Fed finds itself in now, less than 72 hours after the U.S. elections. It may not be possible, given the Fed’s current set of tools, for monetary policy to replace the shortfall in fiscal policy to deliver broad-based economic prosperity. At best, it may be confined to primarily propping up asset holders and debtors, then relying on the hopes of the wealth effect to make its way through the economy. If such a trickle-down effect does in fact occur, it may not come about fast enough to save a threatened economy just starting to recover.

The Fed could make a more explicit link between its bond purchases and fiscal policy initiatives to push lawmakers into approving more aid, but it is unlikely that the Fed or its chairman wants to play such a political game. The central bank could also widen the availability of its Municipal Liquidity Facility, lowering interest rates and encouraging more states and cities to take out loans. But for now, the Fed seems resolved for the facility to remain a last-resort backstop rather than a substitute for federal grants.

Put it all together, and it is hard to see how the Fed would make up for a smaller dose of fiscal aid on its own. It did move last week to sharply reduce the minimum loan size in its Main Street Lending Program to $100,000 from $250,000, potentially making it open to a broader swath of U.S. businesses. But with fewer than 400 loans made since the program became operational in July, and just 14% of Main Street lending done through the end of September for loans of less than $1 million, it’s questionable at best whether it’ll receive widespread interest. Powell himself has stressed that these businesses may need grants, not loans that they must repay, to get through the pandemic. Also, as it stands, the program is set to expire on December 31st, as is the muni facility.

With the prospects of a smaller fiscal package in the face of rising coronavirus cases in Europe and the U.S., leading to more restrictions on business and social activity, the Fed is left to take on an even higher role in supporting and encouraging the economy. The Fed will have to depend on its tried-and-true monetary policy toolkit – keeping short-term interest rates near zero for even longer, increase the size of its bond-buying program, and/or targeting the longer-end of the yield curve, as deemed necessary. This may be all the help the Fed can provide to bolster economic activity with a smaller fiscal package, helping to keep bonds well-bid, corporate debt deals flowing, and equity markets elevated. But will this be enough? It has proved effective in recent months, as ultralow yields have helped fuel demand for riskier assets, such as stocks, and led to a surge in borrowing by companies, while Americans have rushed to buy new homes or refinance their existing mortgages. There is a lot left to still play out over the upcoming weeks and months.

The U.S. labor market strengthened again in October

Defying expectations for more subdued gains amid an intensifying pandemic and lack of additional fiscal relief, nonfarm payrolls increased by 638,000 in October. This, despite a 147,000 decline in temporary Census workers, and after an upwardly revised 672,000 payroll gain the prior month, according to a Labor Department report Friday. This October gain compared with a median estimate of economists calling for a 580,000 payroll increase.

The unemployment rate fell by 1 percentage point to 6.9%, a bigger drop than economists projected, though the number of long-term jobless Americans surged and now makes up a third of those out of work. Jobs remain 10 million below pre-pandemic levels, and with coronavirus infections rising at a record rate this week, maintaining the pace of hiring may be difficult. The number of permanent job losers was little changed at 3.7 million in the month, a positive sign after two straight significant increases.

Other figures point to an increasingly precarious labor market beneath the headline numbers. The number of long-term unemployed, or those jobless for 27 weeks or more, increased by 1.15 million to 3.56 million, the highest level since early 2014.

Colder weather will also challenge businesses like restaurants that have depended on outdoor dining when many Americans are fearful of gathering indoors, making the economy’s path highly dependent on the development and distribution of a successful vaccine, especially if virus restrictions re-emerge as they have in other parts of the world. In addition, the congressional election results this week reduced the chances that any new stimulus will be as massive as Democrats sought, meaning limited cash for the unemployed and businesses most affected by the virus.

Despite all the near-term uncertainty over fiscal stimulus and an increasingly spreading coronavirus, to date progress in the U.S. labor market is holding up as household savings help fuel spending and business investment rebounds, helping to provide the incoming government with an economy that is actually in relatively better shape than many analysts expected just six months ago.

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