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MainStreet Macro: The Handshake

January 25, 2021 | read time icon 5 min

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One of the first things to disappear during the COVID-19 pandemic was the handshake. In the midst of the contagion, the greeting was quickly replaced by the fist bump, then the elbow bump, then (my personal favorite) a quick wave behind a masked smile. 

Now that handshakes have all but vanished from the planet, Main Street businesses are gearing up for a new form of outreach from the Biden administration.  It’s the non-physical, but just as tangible embrace of aggressive monetary policy with an ambitious Go Big or Stay Home fiscal spending package.

President Joe Biden’s $1.9 trillion COVID relief package and the Federal Reserve’s $2.3 trillion (and counting) bond-buying program add up to a vigorous handshake between fiscal and monetary policymakers. Last week, Janet Yellen, the former Fed chair and incoming Treasury secretary, told Congress to act big on spending or risk more dire consequences for the economic recovery.

This week, we expect Yellen’s former colleague, Fed Chair Jay Powell, to assure markets that rock-bottom interest rates and Fed bond purchases are here to stay for quite a while longer. Their joint focus is on propelling economic growth and returning the unemployment rate to its pre-pandemic low, while putting off inflation and debt concerns to be dealt with in the future. 

Finding the Target

The coronavirus has had a sharply bifurcated effect on the economy. Last week, the stock market hit a new high after rallying 18% in 2020 and blowing past consensus expectations set this time last year, before the pandemic hit. Washington’s unprecedented fiscal and monetary stimulus is fueling the runup.

This year, Wall Street expects the real economy to catch up. Corporate profits could top 20% in 2021, twice the 10% annual average over the past 10 years, according to Factset.

Housing, too, is roaring. Construction starts reached 1.67 million in December, the highest annualized rate since the run up to the housing bust in 2006.

Unlike the market froth that preceded the financial collapse, December’s housing starts are good news. For a decade, builders have struggled to break ground on more than 1.5 million units a year — the historical average dating to World War II – despite population and income growth.

Housing and the stock market are being fueled by that Washington handshake, the combination of low interest rates and big government spending.

But that handshake deal is missing something big: Jobs. As we reported earlier, the country lost jobs in December, especially in leisure and hospitality. Those hard-hit sectors tend to be the lowest-paying, meaning low-income households have born the brunt of the pandemic’s economic pain.

Source: ADP NER

For policymakers, the 2020 strategy of throwing fistfuls of dollars at everything might need to give way to an approach that targets the businesses, workers and communities that need help most.

Enter the Biden stimulus. About $160 billion of the relief package would fund the new administration’s pandemic response, including a national vaccination program, expanded testing, and public health. That’s a no-brainer, at least to this Main Street economist.  The seven-day moving average of Covid-19 case counts is 2.5 times what it was in July and shutting down this disease is job number one.

But let’s look at another big-ticket item in the Biden plan, a $1,400 direct payment to individuals, including children, totaling $450 billion. The payments, which make up about 22% of the administration’s relief package, would add to the $600 per person pledged by December’s stimulus and the $2,000 payments Congress approved as part of the Cares Act last March.

It might sound like a winner, but here’s where direct payments get tricky.

Wealthier households tend to spend when they’re confident in the economy and save when they’re not. Low-income consumers tend to spend more when they have more to spend. The top 10% of earners spend about two-thirds of their after-tax income, while the bottom 90% spend almost everything, according to the Labor Department’s Consumer Expenditure Survey.

In the early days of the pandemic, the government’s direct payments combined with solid consumer balance sheets to boost retail sales after the initial economic shutdown last year.

But retail sales have slowed in the past two months as infections spread and demand weakens–we’re not going to Disney World just yet. People are saving, not spending, and economic growth has slowed.

The Cares Act, the first round of stimulus, provides a clear picture of the problem. Its $2,000 direct payment juiced the personal savings rate when it was rolled out in April. Nine months later, the rate remains above its historic average. Workers who continued to collect their usual paychecks during the pandemic basically just put the money in the bank.

Would another round of direct payments provide the economic bang for the buck? And will timing the payments before the full extent of the vaccine rollout prompt people to save again instead of spend, limiting their stimulative effect on the economy? (DM us at @ADPResearch with your thoughts!)

Source: St. Louis Federal Reserve Economic Data

Water damage

To date, the federal response to the economic downturn has totaled over $3 trillion, or 17% of GDP. It’s unprecedented. If Biden’s plan gets the OK from Congress, the total would rise to $5.2 trillion, or around 25% of GDP. To put it colloquially, that’s a whole lotta money. For context, the fiscal response to the 2008- 2009 recession was less generous, totaling $1.5T (roughly 10% of GDP).

One common justification for spending during an economic downturn is that you can’t worry about the water damage when you’re trying to put out the fire.

The water damage in this case is the federal debt. Get used to seeing this chart as Washington’s deficit hawks are roused from their slumber and start making noise again.

Source: St. Louis Federal Reserve Economic Data

As of Jan. 13, the Fed held $4.7 trillion in Treasury bonds, about double the securities in its coffers just a year earlier. Last March, the central bank pledged to buy Treasurys for as long as necessary to ensure that businesses and consumers could tap low-cost borrowing.

The Fed is spending $120 billion a month to add to its Treasury stockpile and has no plans to stop, a commitment Powell confirmed earlier this month when he said the central bank had learned its lesson about tapering down purchases before the economy was ready.

“The economy is far from our goals,” he said, and restated the Fed’s commitment to use monetary policy “until the job is well and truly done.”

As handshakes go, that’s a strong grip. But the handoff to the economy comes with a big price tag in the future.

For additional insights on the Post-Pandemic Market, review our SPARK blog HERE.