Morning Commentary: The Fiscal Fumble

Foreign Exchange - Morning Commentary
The Fiscal Fumble
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
On a global level, the massive injection of fiscal stimulus in the second quarter helped to prevent an even larger contraction of the global economy. But at the individual country level, there was a tremendous variance in fiscal response and subsequent economic performance.

The biggest difference in policy support across countries was the degree of support for the household sector. By comparing disposable personal income (DPI) before the crisis to DPI at the peak of the crisis, we can proxy how much of the drop in labor and other income was offset by policy support.

Most countries only partially offset the drop in income. For example, DPI dropped by 2.4% in the euro area as a whole, with Italy and Spain dropping by ~9% each. Conversely, Canada, the U.S., Korea and Australia stand out for how each country flooded the household sector with support. In the U.S. and Canada, DPI rose about ~10%. Yet despite this, the U.S. GDP only fell 4.2% less than Europe (-10.1% versus -14.3%) even though DPI growth in the U.S. was ~12.4% higher. This is likely due to shutdowns making it difficult to spend and poorly targeted stimulus, such as Payroll Protection Program payments, going to businesses even if they planned on retaining employees.

This interplay between policy, income and GDP showed up in other countries as well. The U.K. and Canada both had strong fiscal responses but had sharp drops in GDP due to Brexit and relatively large and persistent COVID-19 outbreaks (U.K.) and the triple blow of a shutdown, falling trade with the U.S. and falling commodity demand (Canada).

Looking ahead, risks remain to the downside. For most countries in Europe, fiscal stimulus was already too small and is already starting to fade. The EU recovery fund was supposed to make up for the lack of local stimulus but is running into issues and could be delayed. As for the super-stimulators, Korea, Canada and Australia have done a relatively better job containing the virus and have governments better able to move forward with more fiscal action as needed.

The U.S. situation is more concerning. The huge fiscal injection from spring is still supportive — hence stronger economic data relative to Europe. However, most fiscal measures were designed to provide short-term support, and COVID-19 numbers remain relatively high. This last point is particularly important as activities move indoors due to colder weather.
  • U.S. stimulus talks remain gridlocked, with House Speaker Nancy Pelosi asking the White House to revisit its $1.8 trillion offer. While there are many sticking points, Senate Republicans remain a key one, as their acceptable stimulus amount is not only less than what Democrats want but also less than what the White House has proposed. In fact, Senate Majority Leader Mitch McConnell is planning on voting on an even skinnier bill than the one Senate Republicans previously passed.
  • Brexit talks continue ahead of this week’s EU summit. Notably, Irish Deputy Prime Minister Leo Varadkar said there is a greater than 50% chance of a skinny deal. On the margin, a skinny deal is better than no deal, so this would be positive for the pound. Given this, a skinny deal has many negative elements of a no-deal exit, so any upside should be limited.
  • Uncertainty is rising in the U.K. beyond Brexit. The National Security and Investment Bill being discussed would give the U.K. government the ability to act pre-emptively and retroactively on foreign investments in critical sectors. Clearly the passage of this bill would damage inbound investment sentiment, a critical source of support for the U.K. economy. Of course there is also the Internal Market Bill that has caused issues internally and externally and the U.K.’s highly criticized three-tier COVID-19 reaction plan.
  • The EU recovery fund continues to hit road bumps, as Poland is threatening to veto the plan. A unanimous vote is needed to pass the EU budget and recovery plan. At issue is the rule of law clause that seeks to link democratic standards to any funds from the EU. Hungary and Poland are the countries most impacted, as their “illiberal democracies” conflict with EU ideals. Ultimately, passage is expected, as all countries need the recovery fund, but near-term noise is expected to weigh on the euro.
  • Eurozone industrial production slightly missed expectations at +0.7% month over month against expectations for a 0.8% increase. The recovery is expected to continue in Europe, but as more restrictions get re-imposed due to rising COVID-19 numbers, more stimulus will be needed on the monetary and fiscal front.
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