Head Research Analyst at Bovell Global Macro.

Do the Fed Have Any Ammunition Left?

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The markets continue to wait for the results from this week’s US elections, and as expected, the Federal Reserve stayed pat on policy at yesterday’s meeting. One thing that is starting to become clear is that a large fiscal package is not coming, so the burden will now be on the Fed to support the economy.



Where Do We Stand on Fiscal Stimulus?


Prior to the elections, the Trump administration and House Democrats were deadlocked in stimulus talks. Although they were able to narrow their differences it was simply not enough to reach an agreement on a new stimulus package. In any case, there was a lot of uncertainty as to whether the Senate Republicans would have approved any stimulus package. The package being negotiated would have been worth almost $2 trillion, whilst Senate Republicans did not want to go above $1 trillion.


We are now awaiting the election results of what has turned into a very tight race. In the days before the elections, the markets started pricing in a ‘blue wave’ but those hopes have now been dashed. The Democrats have retained the House, albeit with a smaller majority. Meanwhile, the Republicans look set to win a small majority in Senate whilst Biden is in prime position to take the White House. This will mean a political gridlock for at least the next two years. It would prevent Biden from passing sweeping changes such as a significant hike in the capital gains tax rate, which is a positive for the markets. However, it also prevents any large stimulus package from coming into the economy.


At most, we could get a package of $1.5 trillion under a Biden administration and a Republican-controlled Senate. However, it could be some time before any package is negotiated and it will do little to help many of the businesses or individuals who are struggling right now. We also have a resurgence in the coronavirus across Europe and the US, which is likely to slow the economic recovery in the coming months. The focus will now be on the Federal Reserve and what they will do, but it’s difficult to see how much more they can do at this point.



What Are the Options for the Federal Reserve?


When the coronavirus pandemic kicked off earlier this year and large areas of the world were forced into shutdowns, the Federal Reserve launched a range of monetary easing measures including an unlimited quantitative easing package. Since then, they have also adopted average inflation targeting which means that rates will remain at the current levels for a long time. Beyond this, there are few options for the Fed to really provide the kind of stimulus needed.


Multiple Fed members have made it clear that they would not support a move to negative rates. The current lower bound is 0%, which means rate cuts are off the table. Yield curve control was briefly discussed but the Fed has shown reluctance to use this measure. That leaves the option of further quantitative easing. It is difficult for the Federal Reserve to do too many different things considering the broadness of the current QE program. I would also question how effective further QE would be. Although quantitative easing may have provided support in the early parts of this year, that support was arguably more effective for the markets rather than the economy. This is a key reason behind the Fed pushing quite desperately for fiscal stimulus from the government.


Government spending gets support to the consumer much quicker than monetary stimulus. The markets have recovered considerably this year, but the consumers will find themselves struggling in a few months as fiscal measures start to fade out. If the Federal Reserve are to ease further, they probably need to be more innovative and pull out more unconventional measures.



What Are the Markets Looking For?


Stimulus. The markets do not really care too much about where it comes from, but they are looking for stimulus. We already have ongoing quantitative easing from the Federal Reserve, but the markets will either want to see a pick-up in the pace of QE or a fiscal package from the government.


As we put the US elections behind us, I am expecting equities to rally. The sustainability and pace of this rally will hinge on the level of stimulus we get in the economy in the coming months. It’s important to remember that the recovery is only just getting underway, and the global economy remains in a fragile state. The lack of further stimulus will cause the recovery to falter and this will feed into the stock markets.

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