Morning Commentary: The Cost of Gridlock

Foreign Exchange - Morning Commentary
The Cost of Gridlock
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Yesterday, US equities finished higher and have opened positive today on the back of positive headlines on fiscal stimulus.  While yesterday’s negotiations didn’t result in an agreement, it yielded enough progress for the Democrats to delay their vote and extend talks another day.  With both sides stuck due to pre-election posturing, reaching a compromise becomes increasingly difficult the closer we get to Election Day.  This raises the question of how long fiscal stimulus from the spring will continue to support growth before it fades.  

In an effort to do this, we turn to a model created by the Brookings Institute that attempts to estimate the impact of fiscal policy on GDP growth from the federal, state and local levels as well as automatic stabilizers.  The impact of fiscal policy comes on growth through both the “multiplier effect” of each spending action and the lags.  Additionally, the model depends on spending assumptions.  For example, the model assumes consumers spend 90% of unemployment benefits but uses a lower propensity to consumer for other programs.  This makes sense as a lot of stimulus funds went to households in less distress.  

In total, the Brookings Institute estimates that stimulus offset 1/3 of the shock to the economy.  Unfortunately, stimulus is rapidly fading and is expected to turn negative by the end of Q1 of next year.  Between now and then, the economic recovery should continue to improve, but this overall growth does makes some ugly undercurrents.  For example, some people who received PPP payments and stimulus checks were not under stress, leading to more spending than normal.  Additionally, not all businesses that were able to survive due to PPP funds will be able to continue without further help.  

The last recession provides a good example of the dangers of policy gridlock for an economy coming out of a major recession.  During the last recession, the economy received a huge fiscal boost through the $831 billion American Recovery and Reinvestment Act of 2009.  But this proved to be the only stimulus package as Democrats lost control of the House, freezing discretionary spending.  From 2010 to 2015, fiscal policy was actually a headwind to GDP growth and resulted in a slow recovery with low inflation and sustained super easy Fed policy.  

This is a relevant lesson as polls suggest Washington DC gridlock as a possible outcome this election cycle.  Senate Republicans are already pushing back on further deficit spending ahead of the election and with a Republican President pushing for a stimulus package.  After the election, and especially if there is a Democrat in the White House, this opposition is likely to grow and risks a repeat of the slow recovery seen last time around.
  • US initial jobless claims came in at 837K which beat estimates for an 850K print.  While this week’s claims number represents an improvement over last week’s revised 873K number, initial jobless claims remain significantly higher than where it was pre-pandemic.  Adding additional pressure to the labor markets going forward are the furlough announcements from a variety of industries including two major US airlines.  The CARES act provided support to airlines under the condition of no layoffs or pay cuts before October 1.  With no new stimulus in place yet and passenger traffic back to only 1/3 of pre-pandemic levels, airlines have been forced to take action.  To this point, airlines indicated they would reverse course if the government agreed to additional support in the coming days.   
  • Initial optimism around Brexit talks have begun to fade as reports indicate the EU is preparing to send the UK a “letter of formal notice” for breaching the Withdrawal Agreement that could set up for a potential lawsuit.  
  • Japan’s Tankan index came in weaker than expected at -27 versus expectations for a -24 print.  It’s worth noting that the reading out of small businesses is significantly worse than out of larger ones.  
  • The Tokyo Stock Exchange, which is the world’s third largest exchange, halted trading for the entire session due to a technological glitch.  Trading is expected to resume as normal tomorrow.
  • Q3 2020 was the worst third quarter on record for large corporate bankruptcies.  US filing show that 70 companies with more than $50 million in liabilities filed for bankruptcy protection.  Retail and energy made up a significant portion of these filings.
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