The bond and equity markets are signalling that peak growth and peak earnings have either been achieved or, given that markets are forward-looking, about to be reached.
In response to the pandemic, the US spent nearly $US5 trillion in about 18 months. With that spending almost exhausted, fiscal policy will be tightening in the US even if Biden is able to get his agenda past the Republicans in the Senate.
The other dilemma for the Fed is that the pandemic hasn’t gone away.
While more than half the US population is fully vaccinated and near two-thirds have had at least one shot, the politicisation of vaccines and other non-medical measures in the US and the outbreaks of the Delta variant mean the pandemic is still weighing on regional segments of the economy.
At the same time companies have been reporting labor shortages, supply chain disruptions, increasing raw material costs and cost inflation more broadly. They are raising prices in response, baking in some inflation.
It is a messy and uncertain mix of influences that the Fed is considering and the financial markets backdrop doesn’t provide much guidance.
Bond yields remain modest, although they’ve inched up from last month’s lows. The 10-year bond yield is 1.36 per cent, well below the 1.75 per cent reached in March. The sharemarket, which was consistently posting records earlier this year, has faltered in the past fortnight, sliding about 2.5 per cent.
It could be argued that the bond and equity markets are signalling that peak growth and peak earnings have either been achieved or, given that markets are forward-looking, about to be reached.
What the Fed does and says matters, given that it sets the reference rates for most other economies, influencing their monetary policies and currency, bond and equity markets in the process.
A decision to back out of the Fed’s latest bout of quantitative easing and, at some later point (but potentially as early as the first half of next year) to start raising US interest rates, will have global effects and not just on financial markets.
Government debt in most economies has exploded in response to the pandemic. Ultra-low rates have also seen corporate leverage in the US and some other markets rise significantly.
The amount of “junk” debt issued in the US so far this year already surpasses any full year on record while the Institute of International Finance has said that total global debt hit a record $US296 trillion in June. In June 2020, it was about $US270 trillion.
Any increase in US and global interest rates will therefore have a far greater impact on debt-servicing costs and the sustainability of debt than it would have had pre-pandemic.
There is also a political context to the Fed’s deliberations, with Joe Biden weighing up whether to extend Powell’s tenure as chairman for another term or replace him with someone more acceptable to the “progressives” in his party.
Replacing the Fed chair even as Congress continues to indulge in brinkmanship over the US debt ceiling, edging the US ever closer to a technical default on its debts, would add another element of uncertainty and risk to US economic management.
Within the next few weeks, starting with this week’s Fed meeting, the outlook for some of the most critical economic decisions the US is confronted with – monetary policy, the Fed’s chair, the debt ceiling and Biden’s economic agenda – will become clearer. Given the implications of these decisions, for not just the US but the rest of the world, it is to be hoped that they decide wisely.
The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion. Sign up to get it every weekday morning.