Fed to signal willingness to accommodate fiscal boost - Capital Economics
US Economics

Fed to signal willingness to accommodate fiscal boost

US Economics Weekly
Written by Andrew Hunter
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Incoming President Job Biden signed a flurry of executive orders during his first couple of days in office, but it remains to be seen whether the divided Senate will support his broader agenda, particularly his call for more large-scale fiscal stimulus. We expect the Fed to stand pat at next week’s FOMC meeting but, in his post-meeting press conference, Chair Jerome Powell could add his support for more fiscal action – and reassure that such action wouldn’t prompt the Fed to tighten monetary policy any time soon.

Incoming President Job Biden signed a flurry of executive orders during his first couple of days in office, but it remains to be seen whether the divided Senate will support his broader agenda, particularly his call for more large-scale fiscal stimulus. We expect the Fed to stand pat at next week’s FOMC meeting but, in his post-meeting press conference, Chair Jerome Powell could add his support for more fiscal action – and reassure that such action wouldn’t prompt the Fed to tighten monetary policy any time soon.

Biden’s executive actions will, like his predecessor’s, have a mixed impact, with some amounting to little more than virtue signalling. For instance, announcing that the US will immediately re-join the Paris Climate Agreement signals that Biden’s administration sees tackling climate change as a key priority and fits with his campaign pledge to “ensure the US achieves… net-zero [GHG] emissions no later than 2050”. But what really matter are the concrete steps that the administration takes within the next four years to put the US on a realistic path to achieve that goal.

To that end, while Biden was able to cancel the Keystone XL pipeline permits and stop drilling on some Federal lands, he otherwise only instructed agency heads to begin reviewing regulatory changes made during the Trump administration and to set up new inter-agency working groups. The head of the EPA has until September this year just to propose new limits on methane gases, and the working groups are not expected to report back until next year.

In her nomination hearing earlier this week, Biden’s pick for Treasury Secretary, Janet Yellen, repeated the new President’s call to “act big” on fiscal stimulus. She argued that, with the interest cost falling even though the debt burden increased markedly over the past 12 months, the US could afford to do a lot more. But the centrist Republican Senators like Mitt Romney have sounded lukewarm on the need for another stimulus as big as $1.9trn, which is nearly 9% of GDP, and even the Democrat Joe Manchin has given conflicting signals on whether he supports some of the measures put forward. So Biden will either have to scale down his proposals to garner bipartisan support or go down the budget reconciliation route – that requires only a simple majority, but would take longer and limit the scope for any additional support until the next fiscal year begins in October.

We have assumed that a $1trn package will be passed within the next few months, with a much smaller stimulus focused on longer-term investment following much later this year. But the uncertainties surrounding the path of fiscal policy are almost as big as those surrounding the evolution of the coronavirus. Biden could still get everything he is asking for or, at the other extreme, nothing.

Fed likely to welcome more fiscal support

Aside from acknowledging the weakness in the incoming economic data in its policy statement, we expect the Fed to leave policy unchanged at next week’s FOMC meeting. The prospect of more fiscal stimulus has led to speculation that a strong economic recovery could prompt the Fed to withdraw monetary support sooner than anticipated. But we expect Chair Jerome Powell will use his post-meeting press conference to reinforce the message that the Fed would be tightening policy “no time soon”. The Fed clearly views its short-lived tightening several years ago as a mistake and is much more likely to err on the side of caution this time around – to avoid another “taper tantrum” in the bond markets.

The week ahead

With the Fed’s policy meeting likely to be a low-key affair, the focus next week will remain on the new President and efforts to get his key administration nominees confirmed by the split Senate. Otherwise, we estimate that fourth-quarter GDP growth increased by 4.5% annualised.


Data Previews

Durable Goods Orders (Dec.) 08.30 Wed. 27th Jan.

Forecasts

Previous

Median

Capital Economics

Headline orders

+1.0%

+0.9%

-4.0%

Core (ex-transport)

+0.4%

+0.5%

+0.5%

Aircraft orders round out a terrible year

We estimate durable goods orders fell sharply last month, but that mostly reflects weakness in commercial aircraft, with core orders rising further above pre-pandemic levels.

Boeing reported a similar number of net cancellations to previous months in December, but the final month of each year is usually one of their best for orders, so we’re expecting a big decline in seasonally adjusted terms. The production data also point to a modest drop back in vehicle orders, with overall transport orders likely to have declined by close to 15%.

Aside from that weakness, core orders have been holding up well and we expect another solid 0.5% gain in December. (See Chart 1.) However, that would not be enough to offset the hit from transport orders, which is why we expect a large 4.0% decline in headline orders.

Chart 1: Bus. Equip. Prod. & Durables (%m/m)

Source: Refinitiv

GDP (Q4, 1st Est.) 08.30 Thu. 28th Jan.

Forecasts

Previous

Median

Capital Economics

GDP

+33.4%

+4.4%

+4.5%

Renewed restrictions triggered sharp slowdown

We calculate that GDP growth slowed to 4.5% annualised in the fourth quarter, which would leave the economy only 2.3% below its pre-pandemic level from a year earlier.

Almost all that slowdown was due to weaker consumption growth, as the initial bounce back in spending faded and restrictions to curb the spread of the virus were reintroduced. (See Chart 2.) Investment growth has not slowed as sharply, and we expect investment to rise above its pre-pandemic level as low interest rates boosted business equipment and residential investment.

Based on the monthly budget and employment numbers, we have assumed that government expenditure fell by 3% annualised. Finally, we expect that a positive contribution from inventories will roughly offset a drag from net external trade. The Atlanta Fed GDP Now model is factoring in a much larger positive contribution from inventories which is not offset by a bigger drag from net trade, explaining why their model still points to a 7% annualised gain.

Chart 2: Contributions to GDP Growth (% pts)

Sources: Refinitiv, CE

Data Previews

Personal Income & Spending (Dec.) 08.30 Fri. 29th Jan.

Forecasts

Previous

Median

Capital Economics

Personal Income

-1.1%

0.0%

+0.3%

Personal Spending

-0.4%

-0.5%

-0.3%

Fiscal boost to help spending recover soon

We think that real consumption declined again in December but, with new virus cases now falling and the fiscal stimulus set to give a renewed boost to incomes, spending should rebound in January. (See Chart 3.)

The sharp fall in retail sales last month indicates that goods spending was hit by the new restrictions on physical retail stores, although that was partly offset by a rebound in auto sales and a price-related rise in nominal gasoline spending.

Restrictions will also have weighed on services spending, particularly in the leisure & hospitality sector. That said, with the major housing and healthcare components continuing to rise and utilities spending apparently seeing a weather-related jump, overall services consumption probably fell only modestly. We estimate that total nominal spending fell by 0.3% m/m, resulting in a fall of 0.5% in real terms.

Despite the drop-back in employment, we still think that personal incomes increased by 0.3% m/m. Furthermore, the boost from the recent unemployment benefit extension and, in particular, the $600 stimulus cheques will feed through in January, with the promise of an even larger boost to come, if President Joe Biden reaches a deal with Congress on further aid.

Chart 3: Real Consumption

Source: Refinitiv


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Release/Indicator/Event

Time EST (GMT-5)

Previous*

Median*

CE Forecasts*

Mon 25th

No Significant Data Released

Tue 26th

Case-Shiller House Prices (Nov)

09.00

+1.7%(+8.4%)

Conference Board Consumer Confidence (Jan)

10.00

88.6

89.0

90.0

Wed 27th

Durable Goods Orders (Dec)

08.30

+1.0%

+0.9%

-4.0%

Core Durable Goods Orders (Dec)

08.30

+0.4%

+0.5%

+0.5%

Fed Policy Announcement

14.00

0.00%-0.25%

0.00%-0.25%

0.00%-0.25%

Thu 28th

GDP (Q4, 1st Est.)

08.30

+33.4%

+4.4%

+4.5%

Advance Goods Trade Balance (Dec)

08.30

-$84.8bn

-$83.5bn

Advance Retail Inventories (Dec)

08.30

+0.7%

Advance Wholesale Inventories (Dec)

08.30

0.0%

Initial Jobless Claims (w/e 16th Jan)

08.30

900,000

Index of Leading Indicators (Dec)

10.00

+0.6%

+0.5%

New Home Sales (Dec)

10.00

841,000

853,000

850,000

Fri 29th

Personal Income (Dec)

08.30

-1.1%

0.0%

+0.3%

Personal Spending (Dec)

08.30

-0.4%

-0.5%

-0.3%

PCE Deflator (Dec)

08.30

0.0%(+1.1%)

+0.3%(+1.2%)

+0.2%(+1.1%)

Core PCE Deflator (Dec)

08.30

0.0%(+1.4%)

+0.2%(+1.3%)

+0.1%(+1.3%)

Employment Cost Index (Q4)

08.30

+0.5%

+0.5%

+0.6%

Chicago PMI (Jan)

09.45

58.7

58.5

56.0

Pending Home Sales (Dec)

10.00

-2.6%(+16.0%)

-1.0%

Selected future data releases and events

1st Feb

ISM Manufacturing (Jan)

10.00

4th Feb

Productivity & Unit Labour Costs (Q4)

08.30

5th Feb

Employment Report (Jan)

08.30

17th Mar

Fed Policy Announcement

14.00

*m/m(y/y) unless otherwise stated

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts

%q/q ann. (%y/y) unless stated

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021

Q1 2022

2020

2021

2022

GDP

+4.5

+5.8

+10.9

+4.2

+4.2

+3.1

(-3.5)

(+6.5)

(+4.0)

CPI Inflation

(+1.3)

(+1.7)

(+3.3)

(+2.5)

(+2.4)

(+2.4)

(+1.3)

(+2.5)

(+2.3)

Core CPI Inflation

(+1.8)

(+1.8)

(+2.8)

(+2.3)

(+2.2)

(+2.2)

(+1.7)

(+2.3)

(+2.2)

Unemp. Rate (%), Period Ave.

6.8

6.4

5.1

4.8

4.5

4.4

8.1

5.2

4.4

Fed Funds Rate, End Period (%)

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

10y Treas. Yld., End Period (%)

0.93

1.00

1.00

1.00

1.00

1.00

0.93

1.00

1.00

S&P 500, End Period

3756

3900

4000

4100

4200

4300

3756

4200

4500

$/€, End Period

1.22

1.22

1.23

1.24

1.25

1.26

1.22

1.25

1.30

¥/$, End Period

103

103

102

101

100

99

103

100

95

Sources: Refinitiv, Capital Economics


Paul Ashworth, Chief US Economist, paul.ashworth@capitaleconomics.com