It’s still not clear whether Congress can walk and chew gum at the same time. Many of us have been riveted by the Senate’s Impeachment drama (I’m sure that many traders switched their TV’s from financial to news stations covering the trial this week), but it is ultimately a distraction from the work that is most meaningful to market participants. That of course is the negotiations over President Biden’s proposed stimulus package.
Equity investors treat stimulus as a definitive positive for investors. Why shouldn’t they? It is clear that prior fiscal measures were crucial to boosting stock prices. Last year’s rapid rises in major equity indices occurred in the wake of unprecedented monetary and fiscal stimuli. There is ample evidence that many stimulus checks were used to fund investment accounts, new and old. One of the surest ways to excite investors is to present them with a situation that had remarkable prior success – especially when that situation involves free money.
Yet if this is such an obvious boon, why are some prominent economists nervous about the way the stimulus package is currently constructed? Are they simply dismal scientists, or is there something to their concerns?
The biggest and most obvious risk from Biden’s proposed stimulus is that it overheats the economy. It is widely expected that the economy will improve organically after a significant percentage of the population is vaccinated. There is pent up demand for a wide range of services such as dining out, spectator sports, travel and leisure, etc., that is likely to be unleashed over the coming months. Considering that fiscal policy works with a lag, it is not unreasonable to fear that the effects of the coming round of stimulus could arrive just as the economy is already returning to normal.
This is the crux of the argument posed by former Treasury Secretary Lawrence Summers, which he outlined in articles in Bloomberg and the Washington Post. (As a reminder, he served in that role in the Clinton administration and as economic advisor in the Obama administration.) In the latter publication, he wrote: “There is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation.” Federal Reserve Chairman Powell made it clear the other day that the Fed would be deliberately slow to remove monetary stimulus. It is imaginable, if not probable, that we could overheat the economy if it is naturally improving while still digesting levels of fiscal and monetary stimulus that were appropriate to a weak economy.
Summers and others also see Biden’s package as too broad based, and too focused on consumption rather than investment. Few, if any, would deny aid to the millions of Americans who need relief desperately, nor to the many more who find themselves in reduced if not dire circumstances. The concerns rest with the idea of giving aid to all citizens below an income cutoff (set by 2019 tax returns), whether they need it or not. There is an argument to be made that the money would be better spent on a combination of direct relief to those in need along with infrastructure or other long-term investments that could benefit the economy as a whole. Remember that many of these qualms are coming from within the President’s party
Inflation remains the markets’ bogeyman. As we noted recently, the recent steepening of the yield curve reflects a resurgence in inflationary expectations. We have not yet seen inflation in goods or labor, but we have seen it in asset prices. Stock and bond markets are exuberant, and certain sectors (like GameStop) became irrationally so. So far Mr. Powell and many of his counterparts at the Fed are quite willing and eager to engage the possibility for inflation. Will investors be quite so willing if it actually arrives?
Investors need to watch to see if there will be changes to the composition of the package. Stimulus checks received by those without current need will likely find their way into markets, like billions of stimulus dollars before them. Increased unemployment and other benefits based upon need will be far more likely to be spent on necessities. Infrastructure and similar investments are likely to benefit over the longer term.
Will the stimulus package consist of measures that act more like a sugar rush to the markets or more like complex carbohydrates that can provide lasting energy? Investors need to keep a close eye on the stimulus negotiations to determine whether they get a balanced diet or a quick jolt.
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