Economic and market overreliance on stimulus is unlikely to subside

Monte Safieddine is a market analyst at IG Dubai. He has spent nearly a decade in the FX industry and has held roles within financial firms that have included risk, analysis, statistics, and trading. Safieddine holds a Masters in Economics from Wayne State University where he completed multiple PhD-level fields and taught undergraduate students. He provides commentary on financial markets, including FX, cryptocurrencies and commodities, and publishes IG’s Daily Market Report and Weekly Market Report.

Website: https://www.ig.com/ae

And even with both monetary and fiscal policy in full swing, it may not suffice

  

The first Friday of the month is usually when US Non-Farm Payrolls (NFP) out of the Bureau of Labor Statistics is released, and it has a tendency to capture market attention under normal circumstances where more employment translates into more consumption, and in turn aiding the primarily consumption driven economy. The current situation has increased its importance, with policymakers, economists, and investors attempting to note the type of economic recovery we may be witnessing.

Given ADP’s estimate (usually released two days prior to the market-moving figure) was a significant miss, a better than expected figure was a pleasant surprise to market participants. A near 1.8m increase for July, a drop in the unemployment rate to 10.2%, and a rise in the employment to population ratio up to 55% raising hopes that the worst has past on the economic front. The unemployment rate was below 4% before the pandemic and employment to population above 61%, and the gains in payrolls over the past few months have yet to make up for May’s staggering 20.5m loss.

While talk has resurfaced of a U-shaped recovery for countries that have been enjoying improved economic data including expansion for the manufacturing and services sectors for most as per last week’s PMIs (Purchasing Managers Index) out of Markit for the Eurozone, ISM for the US, and Caixin for China, beneath the surface it’s clear that the gains have been thanks to both monetary and fiscal stimulus, without which would have had devastating consequences.

Lower interest rates has enticed more to borrow, including cash-rich companies issuing bonds in an attempt to lock in rates at the lows. The US Federal Reserve’s (Fed) purchases of corporate bond ETFs (as well as individual corporate bonds) has boosted investor confidence that otherwise may have avoided corporate debt which was already a major concern prior to the onset of the coronavirus. That concern is unlikely to subside with rising US-China tensions forcing supply chains to shift in the coming months and years, which in turn would mean companies will be faced with higher costs and in need of liquidity to address any major global strategic geopolitical shifts.

‘Lower for longer’ interest rates, or even the possibility that when the US central bank releases its yearlong policy review may allow for more accommodative policies until certain targets are met are all positive expectations for companies in need of access to liquidity. But while banks may lend out to companies that are expected to weather the storm and investors buy up investment grade bonds that the Fed is likely to snap up at some point in the future, access to liquidity by companies and individuals that can’t generate returns is a major issue.

The latest in global bank earnings showed massive amounts being set aside for rising loan loss provisions, and despite monetary stimulus firing up on all fronts a pool of liquidity isn’t going to make its way through private banks to those that aren’t expected to generate a return be it a company or individual. Households suffering from job losses and companies in sectors that can’t recover even should lockdown restrictions ease further are those at risk. As a result, banks will be wary of lending to companies and households negatively exposed, and those who have trouble servicing current (as well as future) debt.

A lack of access for a significant portion of the economy to liquidity on the monetary front has meant that fiscal policy has been crucial, with payments directly to those that can’t generate returns be it on a corporate or individual level the key method to ensure liquidity reaches those that can’t receive funding through traditional monetary stimulus channels like banks. And it’s that consistent need for fiscal stimulus in the absence of an economic recovery that makes the need for its continuity so crucial.

In the US, few are arguing against fiscal stimulus in general, with the disagreement more of how much and which areas or sectors it’ll be deployed in. Any failure in ongoing fiscal stimulus – and not just for the US – would put recent economic gains at risk of being undone, especially in the absence of a cure and more so for economies that have a heavier reliance on consumption. It would also test popular and closely watched indices seen as a measure for the general economy that have greater component reliance on non-tech sectors. And in an election year, that focus is usually amplified.

* Any opinions expressed in this article are the author’s own

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