The Fed shifts on inflation – What does it mean?
The Fed unveiled a revision to its monetary policy, allowing for higher inflation to help support the labor market. We believe this action could keep interest rates low for years.
Equity markets were down over the past week, with S&P 500 Index down slightly and the NASDAQ Index down just over 1%. In fixed income, 10-year U.S. Treasury yields are now yielding around 57 basis points (bps), falling four bps last week. Investment-grade and high-yield spreads continuing to narrow, which is encouraging.
The U.S. dollar (USD) is clearly starting to break lower. The euro rose around 2%, and the USD is off 9% from its March 23 peak. What is driving this? European data is recovering at a faster pace than the US and last week saw an agreement on a fiscal package for the eurozone that will help some of the peripheral countries. With the global economy starting to recover, the USD is losing its safe-haven status as the global economy recovers. Moves in currency markets will continue to be rocky, but as long as we remain on a path to recovery, we think the USD has peaked.
COVID-19 cases seem to be stabilizing at a very high level. Looking at some of the hot-spot states, new infections are rolling over and net-new hospitalizations have inflected lower. We believe the U.S. is past the peak of this most recent flare up here in the U.S. However, we are starting to see some pick up in cases in Europe and Asia, and we will be watching that closely.
From an economic perspective, the first half of 2020 was extremely weak, with the deepest and shortest recession in history. Despite its brevity, the downturn was extremely damaging. We believe the path to recovery will be sluggish in nature, continuing to ebb and flow as new outbreaks of COVID-19 flare up.
We also believe the second half of 2020 is likely to show positive gross domestic product (GDP) growth. Economic data started to bottom out, beginning in May. However, we expect that growth will not show up in the GDP figures until the third quarter due to the shockingly weak performance in March and April. We are concerned about how far the recovery can run until we get a widely distributed COVID-19 vaccine. While we remain confident of a possible recovery by year end, we believe there could still be a meaningful gap between the levels of GDP in dollar terms versus where it was pre-COVID-19.
Travel and leisure make up 5% of the U.S. economy and that is unlikely to recover much until we get a vaccine. If we see a surge in COVID-19 cases in the fall, we are concerned we could see rolling regional shutdowns. This is not our base case, but we will be watching capacity in the health care system, as another round of lockdowns could be very detrimental to growth and cause a possible double dip. We think we have turned the corner, but the outcome will depend on the path of the pandemic.
On the policy front, it is very clear that policymakers will continue to backstop the system. They will provide as much stimulus as we need to insure the recovery. Global central banks, led by the Federal Reserve (Fed) and European Central Bank, continue to purchase an aggressive amount of securities relative to history, which we believe this could continue for the foreseeable future. The Fed meets later this week, and we expect that interest rates will be kept low for years to come and ultra-easy monetary policy looks set to continue for an extended period of time. Fiscal policy should continue to be a tailwind, as we expect another round of domestic fiscal stimulus. Republicans in the U.S. Senate will reveal their plan today, which is expected to be approximately $1 trillion. The Democrat-led House has already passed a relief package in excess of $3 trillion, so we expect a compromise in the neighborhood of $1.5 trillion is likely.
Timing is important, as there are several programs that are set to expire, including increased unemployment benefits, the moratorium on evictions and the Paycheck Protection Program funding. A lapse in any of these programs could cause a short-term interruption in economic activity.
The U.S. elections are in less than 100 days. Former Vice President Joe Biden is clearly ahead in the polls, but we caution that a lot can happen between now and November. What would a Biden presidency mean? What happens if you combine a Biden presidency with a Democratic takeover of the Senate? We believe a Biden presidency would seek to re-regulate the business community regardless of which party controls the two houses of Congress. While Biden might seem like a moderate in comparison to some of the other Democrat candidates, we believe he would govern to the left of former President Obama.
The Senate comes into play outside of regulatory policy and executive actions and here we think it is important to focus on tax policy. Biden has talked about wanting a significant income tax increase, particularly on high income households. Biden has also focused on a big increase in taxes on corporations. We believe companies will adjust to the possible new reality over the long term, but expect the short-term impact to be negative.
Lastly, there’s China. In Washington, both sides of the aisle are upset with China. When we factor in the upcoming elections, Biden historically has been viewed as being more favorable to China than President Donald Trump, but may take a harder stance than his record might suggest. In comparison to the “go it alone” strategy of the Trump administration, we believe a Biden presidency could be more impactful vis-à-vis China, especially in attempts to rebuild alliances with allies to confront China on issues like intellectual property theft.
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Past performance is no guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through July 27, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
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The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.