Morning Commentary: Many Balls in the Air

Foreign Exchange - Morning Commentary
Many Balls in the Air
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
More than ever, fiscal policy stands as an important factor in determining the US economy’s fate.  The CARES act was the single largest stimulus bill in US history, but its impact has started to fade and lawmakers are currently unable to agree on a follow-up package.   

In an effort to sort through how fiscal policy is affecting the economy, we turn to the Brooking’s Institution’s Hutchins Center that maintains a Fiscal Impact Measure (FIM) that translates changes in federal and state spending into changes in aggregate demand.  

Per the FIM, it appears that fiscal policy has offset roughly 1/3 of the shock to the economy by boosting Q2 GDP by ~15% annualized.  This was broken down as a 14.5% boost from taxes and benefit programs, including the enhanced unemployment program.  Increased Federal spending added a 6.9% tailwind but was offset by a 6.8% headwind from a drop in state and local spending.  

Looking ahead, the FIM is forecasting that fiscal policy will fade in the second half of 2020 and turn negative in 2021 without additional stimulus, granted the 2H 2020 outlook might be too low as they do not account for recent executive orders.  But the 2021 outlook isn’t impacted by executive orders as they are scheduled to expire by yearend.  Should the FIM estimate hold true and there isn’t additional stimulus, then fiscal policy will be a major drag and take 2% off GDP next year. 

If anything, the 2021 estimate could be too optimistic as it assumes a modest increase in state and local spending driven by a reversal of lockdown-related job cuts.  But the risk to this assumption is clearly to the downside especially without federal support that could force significant spending cuts.  

For scope on the potential impact of state and local government “austerity,” we reference the last recovery.  During the first 5 years after the Great Recession, state and local spending reduced GDP by 1.5%.  The risk is for a similar result with Washington making little progress on the next stimulus package. 
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • US initial jobless claims came in at 881K, beating expectations for 950k claims.  It should be noted that today’s number uses a new seasonally adjusted methodology, which makes it difficult to directly compare to last week’s 1.01 million claims print.  Continuing claims fell to 13.3 million from 14.5 million last week but still remain historically high.  The key government employment report will be released tomorrow morning.  
  • The US’s trade deficit came in at -$63.6 billion, the largest trade deficit since 2008.  Within the numbers, the services surplus fell to its lowest level in ~8 years.  Overall, the increase in imports (10.9%) was greater than the increase in exports (8.1%). 
  • The tech war between the US and China continues with China announcing plans to support its semiconductor industry.  The five year plan will focus on third generation semi-conductor production.  On the US side, the country continues to debate the scope and effective date of its WeChat and TikTok bans.  Details are expected to be published around September 20. 
  • Capital flow data shows that Japanese investors were sellers of foreign bonds after being strong buyers prior to last week.  This reduction in investment outflow has been a factor in recent JPY strength. 
  • Australia’s July trade surplus shrank to AUD 4.6 billion from June’s revised AUD 8.1 billion number.  This decline was mainly due to a smaller goods surplus.  The Australian government is also considering pulling forward its legislated tax cuts as well as other policy measures to support the economy.  
  • Canada’s merchandise trade deficit widened to C$2.45 billion from C$1.59 billion last print. 
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