Fiscal Deal Too Late for an Economy at Stall Speed

Trump’s flips flops on stimulus talks are costing you money. President Trump reversed course to rekindle  coronavirus relief talks, which he had called off until after the election only hours earlier, dangling new $1,200 stimulus checks and relief for airlines. Democrats have supported a multi-trillion-dollar relief package while Republicans appear to prefer a series of smaller packages on mutually agreed-upon items. House Speaker Nancy Pelosi rejected the idea of a standalone bill for airline carriers without a larger coronavirus stimulus package. Absent more aid, jobless Americans will be living off their current allotment of benefits from the state or federal government that, in some cases, could amount to just $5 a week. Meanwhile, the Federal Reserve has routinely repeated its concern that a lack of further fiscal stimulus would jeopardize an economic recovery that has more momentum than expected, according to the minutes of the central bank’s September meeting.

Why you should care: Regardless of your political leanings, Congress’s negotiation quagmire and the President’s  changeable appetite for the timing and size of fiscal stimulus spurred a jump in the volatility of interest rates last week, which shows up – directly and immediately – in the cost of interest rate caps and swaptions, among other things.  What is volatility you ask? It’s a gauge that indicates just how much and how quickly an interest rate, like the 10-year Treasury yield or 1-month LIBOR, is likely to change over a given period.  In short, since financial markets are forward-looking, higher volatility = greater risk to the bank that’s selling you the rate cap or swaption, and hence, in an effort to protect themselves from the greater uncertainty that higher volatility implies, the higher the price they charge for them. Are you in the market for a rate cap in the next week? If so, you will likely pay more for it than you would have a week ago.

The sustainability of recovery is becoming an increasingly open question. Amid the recent layoffs announced by US corporations of late (most recently Disney @ 28K, Allstate @ 3.8k, and Goldman Sachs @ 400, and that’s on top of the previous announcements by United Airlines, Ford, Walgreens, Airbnb, Virgin Atlantic, Hilton Hotels, IBM, Uber, Chevron, Boeing, MGM Resorts, Hertz, Lyft, Coca-Cola, Salesforce, American Airlines, NBC Universal, Schlumberger, Daimler and Wells Fargo), combined with the spike in Covid-19 infections and stimulus gridlock, the economic outlook is increasingly cloudy (Derivative Logic is not laying off anyone, in fact we are looking for qualified people to join our team).  After the initial rounds of Fed and Congress-driven stimulus provided a cushion for recovery through late-summer, conditions may soon take a turn for the worse in the job market as aid to small and large businesses runs out. A pre-election fiscal stimulus package – which is unlikely – would arrive too late to stave off tens of thousands of layoffs across both the service and goods-producing sectors, and airlines in particular.

Fed’s meeting minutes leave the door open for more of “whatever it takes”. Minutes from the Fed’s September policy meeting, released last week, indicated that Fed Chair Powell & Co. wanted to retain some flexibility with respect to their new framework on interest rates, given the significant uncertainty of America’s economic outlook.

Our take: The timing of the meeting – the last one before the elections – suggests that the Fed’s economic projections may look strikingly different in November and December, and with them the Fed’s future actions of hiking or cutting rates, depending on the election outcome and the distribution of power in Congress. In short, despite the Fed’s “whatever it takes” rhetoric of late, the Fed is saving its ammunition until then. With the Fed’s available tools for speeding the economic recovery already pushing their limits, the meeting minutes once again showed that the Fed is looking to stimulus actions by the President and Congress – fiscal policy – as both a factor driving a stronger economic rebound and a major factor impacting the risk of a longer/deeper recession. Despite the Fed’s belief that more fiscal help is needed, Congress and the President have been lulled to inaction as financial market improvement and upbeat economic data have diminished lawmakers’ sense of urgency to agree on extending key aid, and now proximity to the election presents another big stumbling block.