Monetary and Fiscal Timetables

Investors, in the week ahead, will have little time for financial analysis.? The headlines will be dominated by the U.S. withdrawal from Afghanistan and the terrible impact of Hurricane Ida in Louisiana.? Meanwhile families will be trying to stretch out summer days, while making all the adjustments necessary for a return to work and school in a still-untamed pandemic.??

However, in the midst of all of this, some significant economic data are due to be released.? In addition, investors should pay attention to the potential timetables for adding further fiscal stimulus and reducing monetary support.

On the data front, Tuesday’s Consumer Confidence reading will be important to see if the recent big decline in the University of Michigan Sentiment index is a genuine sign of increased pessimism.?

Global purchasing manager surveys on Manufacturing and Services, due out on Wednesday and Friday respectively, could show the U.S. losing some ground relative to other countries as Europe, in particular, ramps up its vaccination efforts.? Meanwhile, a variety of employment reports will provide fresh evidence on labor demand and labor supply.? In particular, we expect Friday’s Jobs report to show the addition of roughly 800,000 non-farm payroll jobs, with the unemployment rate falling to 5.2% and wages once again posting strong gains.? And this, rather than confidence readings, will likely provide the clearest sense of the state of the American economy – battered, bruised and distracted - but still on a relatively fast track to full recovery.????

The Federal Reserve is clearly aware of this and, in his Jackson Hole speech on Friday, Fed Chairman Jerome Powell gave analysts some fairly clear signals on how and when the Fed expects to taper bond purchases and begin to raise short-term interest rates.??

First, and most significantly, Chairman Powell noted that he was among the majority of FOMC participants who expected that, if the economy evolved as anticipated, it would be appropriate to begin to reduce bond purchases this year.? However, he has also stated, on many occasions, that the Fed will give markets advance notice of its tapering plans.? Consequently, if the Fed begins to taper in December, it will likely announce that plan at either its September 21st/22nd meeting or at its November 2nd/3rd meeting.

Second, when the Fed begins to taper purchases, it is beginning to look more likely that they will reduce them by $15 billion per month, $10 billion from Treasuries and $5 billion from mortgage backed securities, bringing the reducing the total monthly pace of accumulation from $120 billion in November 2021 to zero by July 2022.? This would allow the Fed to take some time following the end of asset purchases before considering raising the federal funds rate, which they may want to do by the end of 2022.? In addition, at his July press conference, Chairman Powell seemed to throw cold water over the idea of reducing purchases of mortgage-backed securities faster than Treasuries.? His reluctance to do so might reflect the idea that if both sets of purchases were reduced to zero over an eight-month period, there would be little meaningful impact from taking a more aggressive approach in reducing MBS purchases faster, even if super-low mortgage rates are continuing to overheat home prices.

Finally, it is now looking more likely that the Fed will make their tapering announcement in November rather than September.? The stated reasons for this seem reasonable:? The Fed wants to see how the Delta variant is impacting the economy and whether it will wane in the weeks ahead.? They also want to see further signs of progress in the labor market after federal enhanced unemployment benefits come to an end next week.

However, there is also an unacknowledged reason the Fed would like a little more time – they need to know what will happen with fiscal policy.??

The now well-understood state of play is that there should be enough votes in the Senate to get the roughly $1 trillion infrastructure bill passed with bipartisan support but that the bigger, currently $3.5 trillion budget bill, which contains many priorities of the Democrats, can only be passed through the reconciliation process and will need every one of the 50 Democratic and Independent senators to pass it.??

House Democratic moderates had pushed for an early passage of the infrastructure bill.? However, if that occurred, they and Senate Democratic moderates would have much less incentive to vote for the full $3.5 trillion reconciliation bill.??

In a very significant compromise, last week, House Speaker Nancy Pelosi committed to holding a vote on the infrastructure bill by September 27th.? This should force both wings of the Democratic Party to agree on the contents of the reconciliation bill (likely ending up a good deal smaller than the $3.5 trillion bill proposed) by that date.? If they can do so, then the end of September could, surprisingly, see the passage of the infrastructure bill, the reconciliation bill and an increase in the debt ceiling.??

If anything breaks down in this process, however, which is quite possible, then not only would there be complete confusion on actual fiscal policy for 2022, but we could see a federal government shutdown and yet another episode where the U.S. comes close to defaulting on its debt due to its debt-ceiling rules.

For the Fed, it should make sense to wait until the smoke has cleared before adjusting monetary policy.? Consequently, we expect that the Fed will hold off on announcing its tapering timetable until its early November meeting, when they, as well as investors, will fervently hope that the other side of Washington has provide fiscal clarity rather than further home-grown financial turmoil.???

It should finally be noted that clarity on both further fiscal stimulus and the start of monetary restraint, if it occurs, should push long-term interest rates higher, helping stocks relative to bonds and likely boosting value relative to growth.??

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