Monetary vs. Fiscal Stimulus

Stock and bond markets are reacting to yesterday’s Fed announcement (see below). At the moment, the Dow is down 95 points, and the S&P 500 is up .2%. Technology, consumer discretionary and industrial sectors are in rally mode whereas banks, utilities and real estate are falling back. Interest rates (and bond yields) fell, pushing bond prices higher. The 10-year Treasury Note yield edged down to 1.53%. The US dollar strengthened against a basket of foreign currencies, pushing commodity prices a bit lower. WTI crude oil is down .5% to $80.40/barrel, and copper is down about .6%.

Speaking of oil, Bloomberg News ran an article titled, “OPEC+ Tells the World: Your Energy Crisis Isn’t Our Problem.” The OPEC cartel is restraining oil production in order to keep prices elevated. WTI crude has surged from $49/barrel to $80/barrel this year as global demand recovered. And now with US average gasoline prices up around $3.40/gallon, President Biden asked OPEC to consider opening the spigot a bit. His request was quickly brushed aside by the Saudi oil minister. The political irony of Mr. Biden asking for more oil aside, the funny thing is that we as a nation are far more energy independent than this spat would suggest. US producers have the ability to turn on the spigots if they wish. US production has fallen 12% form pre-Covid levels, and the simple reason is that for the first time producers are staying disciplined with regarding to drilling. Every time they goose production OPEC responds by flooding the market with oil and driving prices down. So the mismatch between supply and demand—I guess we’re calling it an energy crisis now?—shouldn’t be blamed on post-Covid supply disruptions, but rather on this long-term fight between OPEC and US producers over who gets to control the market.

As expected, the Federal Reserve announced a plan to begin reducing the amount of bonds it buys each month—called “quantitative easing”—by $15bil each month, beginning this month. Beyond December, the Fed may adjust the pace of tapering (i.e. accelerating) as necessary. So quantitative easing should be wrapped up by mid-year 2022. While Fed Chair Powell acknowledged that “inflation is elevated,” he and other Fed officials continue to judge that this trend is “largely reflecting factors that are expected to be transitory.” In other words, we’re not headed toward 1970s-style runaway inflation. That said, The economy is on a good footing and the next step to removing stimulus—interest rate hikes—will likely be necessary in mid-2022.

As I’ve pointed out in prior updates, there is ample evidence that the economy doesn’t need this stimulus and indeed continuing bond purchases could be counterproductive. Certainly investors are getting nervous that the Fed is behind the curve in terms of removing stimulus. When economic growth is strong and inflation is building, additional stimulus is like pouring gasoline on a fire. The last thing we need is an overheating economy. Of course, I’m talking about monetary stimulus here, but over-doing fiscal stimulus is just as dangerous.

Speaking of over-doing it, the Biden Administration’s much-hyped $3.5 trillion spending plan is begin whittled down in congress. The sausage-making process of “reconciliation” is meant to get around needing 60 votes in the Senate to pass major spending bills. But even that shortcut could be stymied by one or two moderate Democrats who disagree with some parts of the plan. The House, of course, is tinkering with its own version, largely working from the White House’s revised $1.85 trillion plan. And then there’s the separate $1 trillion infrastructure bill, which initially had some bipartisan support but was opposed by some of the more socialist Democrats in the House. Speaker Pelosi hopes to pass both, and likely has the votes. But again, the Senate is the real show because it is split 50-50 between Republicans and Democrats. So whatever comes out of reconciliation must garner votes from every Democratic senator. So far, that’s proving difficult.