Of Stimulus & Deficits

The Dow and S&P500 bounced 1% in today’s trading session, clawing back some of what was lost over the past week. Gains were broad-based; the energy sector shot up 3%, banks & semiconductors were up 2%. The VIX fear gauge fell below 21 and gold declined .4%. Strangely, though, the bond market also traded higher. Fixed income saw some volatility today as the Federal Reserve’s key policy committee announced results from its monthly meeting.

Investors expected the Fed to announce plans to gradually reduce its quantitative easing program. Per this program, the Fed purchases $120bil of bonds each month. During the post-meeting press conference, Fed Chair Jerome Powell noted strength in the economy and said “moderation” of monetary stimulus may be warranted. That certainly seems like an understatement. Quantitative easing will be gradually reduced to zero over the next eight months. But the next step—gradual interest rate increases—won’t come until QE has been eliminated. In this, his comments were possibly a bit more dovish than investors were anticipating. So capital markets reacted positively to the announcement. Investors have enjoyed a steady stream of stimulus, which tends to raise asset (i.e. real estate, stock, bond, commodity) prices. But on the other hand, some are beginning to worry that maybe the Fed has waited too long to begin the gradual removal of stimulus measures. And this could potentially feed inflation. So the Fed is walking a tightrope. For his part, Mr. Powell wants to avoid roiling financial markets and that’s why his approach seems almost ponderous. CNBC Contributor and money manager Karen Finerman likens this situation to a bank robber who says, “If nobody makes any sudden moves, we’ll all get out of here OK.” Thus, one of Jerome Powell’s biggest jobs is to continuously “telegraph” Fed policy intentions.

Much is being made of the federal government’s upcoming debt ceiling decision and politicians on both sides make it seem like this is a critical and dangerous juncture. It is most likely not. You may recall several identical episodes in recent memory (since 2011), which all ended the same way. Congress will wring its hands, shout and stamp its feet, and then vote to increase the debt limit. There’s simply no other choice considering the trillions of dollars of deficit spending enacted during the Covid Crisis. This morning, CNBC reporter Steve Liesman characterized this issue as the “head-fake of this century.”