New Administration, New Challenges: Can Fiscal Stimulus and Fed Cuts Coexist

Stocks rocketed higher yesterday with an everything rally as investors dreamt of a pro-business red wave after Trump's election victory. Bonds suffered painful losses; the cost of all the pro-growth policies expected from a Republican election sweep.

Stargazing. Ok, let's get it out of the way. Trump is the next President of the United States, the Senate has shifted in favor of the Republicans, and the House looks like a lock-up for the Republicans as well. The ball will be in the pro-business Republican court this January. If you strip away the more far-fetched proposals, and even the ambitious ones, the economic policies that will come from the Republican trifecta are, without a doubt, stimulatory to the US Economy.

But let's take a step back and remember that there are two categories of economic controls, monetary and fiscal. We tend to be obsessed with monetary policy, which is under the control of the Federal Reserve, and for good reason. The Fed has, does, and will continue to have its hands on the throttles and brakes of the largest economic engine the world over. The Fed giveth - and the Fed taketh away. Since 2007 and today, it hath given big time on two occasions, saving the economy from epic disasters, and it hath taken away twice, and of those, one was big time. In each of those events there were significant impacts on the economy, the market, and your net worth. So, I guess, yeah, it kind of makes sense for us to be highly obsessed with the Fed's monetary policy. Though following the Fed can seem a bit challenging, policymaking is for the most part these days, pretty straightforward. The Fed signals its moves and is very transparent. For the most part, it either raises interest rates or cuts them. To be clear, the Fed does lots more than just that to control the economy, but interest rates are the big hammer.

Turning our view to fiscal policy - well, that's where things get a bit murky. Fiscal policy is up to the Executive and Legislative branches of government. In a perfect world depicted in Schoolhouse Rock, Congress comes up with policies and sends legislation to the White House where the President either approves or Vetoes. Approvals mean start your engines while vetoes mean going back to the drawing board for legislators. Of course, we know that it is not that cut and dried. What House members and Senators publicly announce is far less than what ultimately ends up in pages 2 through 1000 in those bills sent to Pennsylvania Avenue. Even if page 1 includes massive amounts of cash given out in fiscal stimulus, there is no way to know when, how, and to whom that stimulus will be disbursed. Then there is stimulus that comes directly from the President's pen in executive order. Those can often be seen in video clips of the President signing a bunch of papers surrounded by citizens in need. Those needy citizens rarely leave the White House with bags of cash, though I am told that most receive a commemorative coin, and some even get drink coasters with the Presidential seal. As we have also witnessed, even Presidential executive orders can be challenged in court, holding things up or even reversing the decisions. You see where I am going with this? Fiscal policy does, indeed have massive impacts on the economy, but is very difficult to follow its path from mouth to pen, and ultimately to pocket. But to be fair, some fiscal stimulus is very clear. Two examples are the tax cuts from the 2017 TCJA and the direct stimulus checks received by many during the pandemic. Both of those took careful coordination from the House, the Senate, and ultimately the President.

So, here we are with both monetary and fiscal stimulus expected in the coming, let's call it, year. The Fed is clearly on a path of interest rate cutting, while the freshly red-painted White House and Congress is likely to churn out stimulative legislation. That should ultimately be very stimulative for an already, what appears to be, pretty healthy economy. If that is where our story ended, then we would have the happy ending that all want. But unfortunately, as we have learned, nothing is straightforward and simple when it comes to the economy and how the markets react. If you have only ever read one economics book in your life and found it boring and difficult to understand, you surely walked away learning that it is bad when economic growth declines, and that things can get even worse when an economy runs too hot and causes inflation. Inflation, you know the stuff that has historically caused heads of state to literally lose their heads, and even caused world wars - more death. So, yeah, inflation is important.

Having said that, the US economy has just suffered the worst spate of inflation in decades. Three principle causes of that inflation can be traced to pandemic-era supply chain disruptions, a long period of loose monetary policy, and massive fiscal stimulus. Thankfully, that inflation has settled down, and appears to be headed back to normal. So, what can we expect between now and, say, the end of next year, based on what we know TODAY?

Well, it looks like the new administration and Capitol Hill will be in a position to stimulate. Let's call that a high likelihood of fiscal stimulus. With respect to supply chains, expected tighter trade policy has the potential to disrupt supply chains. More specifically, tariffs unarguably, are inflationary. Never mind trade wars which can disrupt shipping. That leaves us with inflationary monetary stimulus and inflationary trade policy, leaving the lonely Federal Reserve in a tight spot. If the Fed adds monetary stimulus to the mix, that could be a tinderbox for another wave of painful inflation. We know this, we have seen this, we don't want this. So then, what is the Fed to do?

I would suspect that topics similar to these have been discussed by FOMC members, who began their deliberations yesterday, and will release policy decisions today. The Fed is largely expected to lower interest rates by 25 basis points; even my local news station said so. Most economists expect that, and futures markets predict it as well. Similarly, a general consensus is that the Fed will cut by another 25 basis points in their December 18^th meeting (73% chance). Ok, you are probably thinking "why would they do that given what Mark just told us, IN LONG FORM, above?"

To be clear, the current Fed Funds target of 5% is still quite restrictive. In other words, the Fed's foot is still firmly on the brakes. Even if the Fed cuts another by 50 basis points between today and the end of the year, the Fed's foot would still be on the monetary brakes. You see, there is this magical number followed closely only by nerds and academics… and me. That number is r*, pronounced r-star in the nerd community. That is the natural rate of interest, or the neutral interest rate. It is a rate which is neither stimulative or restrictive, leaving growth up to the economy itself… AND FISCAL POLICY. You can pull out that one economics textbook that you probably kept in order to prove to your children that you know what's up, and you can search for r*, but you will not find it. You will never find it in permanent ink. That is because it is kind of a moving target and is unobservable. There is good news, though. Smart people are always attempting to calculate it. "SO, WHAT IS IT, MARK," you exclaim. Well, the New York Fed thinks that it is 1.1% while the Richmond Fed thinks that it can be as high as 2.2%. Remember the Fed Funds Rate, this morning, stands at 5%. That gives the Fed at least another 2.8% room for cuts before policy is considered to be non-restrictive. Go on, read that again.

Why am I telling you all this? Well, because the Fed is going to be even more important in 2025 than it is today, if you could possibly imagine that. This afternoon, the Fed Chair will do his post-announcement presser in which he will surely be - er, pressed to give up some hints on what the venerable clan of bankers is thinking, given yesterday's election results. Listen carefully, but don't expect Powell to say anything other than that the Fed is independent and that all of its moves will be data dependent. For now, the data shows that the Fed has plenty of room to cut interest rates and still keep things in order. However, there is no rush, given recently positive economic data -- and the economic "unknowns" that will come in the year ahead.

YESTERDAY'S MARKETS

NEXT UP

• Initial Jobless Claims (November 2^nd) is expected to come in at 222k, slightly more than last week's 216k new claims.
• At 2:00 Wall Street Time, The Fed will release its monetary policy. At 2:30, Chairman Powell will have a press conference.
• This morning's earnings: Moderna, Yeti, Ralph Lauren, Becton Dickinson, Tempur Sealy, Tapestry, US Foods, Vistra, and TranDigm all beat on EPS and Revenues, while Hershey, Medical Properties Trust, CommScope, Penn Entertainment, PG&E, Carlyle Group, Rockwell Automation, Duke Energy, Halliburton, andWarner Bros Discovery came up short. After the closing bell earnings: Block, Expedia, Fortinet, Lucid, Sunrun, Cloudflare, Rivian, Sweetgreen, Dropbox, DraftKings, Lumentum, Pinterest, Monster Beverage, Airbnb, Toast, and Motorola Solutions.

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