Global Daily – Fed Preview + German fiscal stimulus

by: Bill Diviney , Aline Schuiling

FOMC Preview: Three things to watch for this evening – The June FOMC meeting began yesterday, and will conclude this evening. There are three key items to look out for at this meeting. First, the Fed will release macroeconomic projections for the first time in six months, having skipped releasing these in the midst of the crisis in March. Official institutions in general have tended to forecast bigger 2020 downturns, but also more robust 2021 recoveries, leaving the net impact relatively small compared to consensus and especially our own forecasts. For markets, how the Fed sees the economy by end 2021 will be a key focus. Regardless of the Fed’s forecasts, the complete lack of inflationary pressure means that there is close to a negligible risk of withdrawal of accommodation over the next 18 months, so the implications for monetary policy of the Fed’s forecasts are small at this stage.

Powell likely to reiterate appeal for more fiscal support – Where the forecasts might have considerably more importance is in bolstering the case for further spending by the federal government, and indeed, the second key thing to watch for is that Chair Powell is likely to continue to appeal to Congress to increase its fiscal support to the economy. A dovish set of forecasts, and/or a dovish tone to Powell’s description of the outlook, would also help to push back against rising bond yields. Yields have moved higher on optimism over the pace of recovery – particularly in the wake of the dramatic upside surprise to payrolls last Friday. We think this optimism is misplaced given that activity indicators remain subdued, and we suspect many on the Committee will be thinking the same.

Yield caps could be imminent – Finally, Powell is likely to be questioned in the press conference on the potential for yield caps being introduced as the next policy move. The recent recovery in yields could give greater urgency to this topic, and Powell is likely to acknowledge in the press conference that the Committee is actively discussing the matter – and may even hint that a decision is imminent. Recent yield moves raise the risk to us that yield caps could be implemented as soon as the next FOMC meeting on 28-29 July. The goal would be to ensure policy remains accommodative through the recovery, rather than to provide additional accommodation, although it could in future (in theory at least) be used in such a manner by lowering the yield cap actively. Indications so far are that yield caps would be introduced at the short end (eg. 2-3y, as implemented by the Reserve Bank of Australia) rather than the long end of the curve (10y, like the Bank of Japan). (Bill Diviney)

Euro Macro: Germany’s fiscal package to support consumption and green investment – Germany announced an extra fiscal stimulus package of EUR 130bn (equal to around 4% of GDP) last week. Of this total package, EUR 25bn consists of support to small- and medium-sized companies, which will be financed from a previous support package, implying that the total extra stimulus is EUR 105bn (around 3.2% of GDP). Besides the support to small- and medium-sized enterprises, a main element of the new package is a temporary cut in the VAT rate (the standard rate to 16% from 19% and low rate to 5% from 7%), which is estimated to cost EUR 20bn (0.6% of GDP) in total. Also, parents will receive a cash handout of EUR 300 per child (total costs estimated at EUR 4.3bn), while expenditure on basic costs (e.g. housing) for the unemployed will be expanded (around EUR 10bn). Furthermore, household and company income will be supported by a reduction in the renewable energy surcharge on electricity bills by a total amount of EUR 11bn. Last but not least, around EUR 50bn of the stimulus (1.5% GDP) will be a wide variety of “future investment”, which is aimed at raising Germany’s longer term growth potential and supporting the transition towards a greener economy. These investments will be on, for instance, health care (EUR 4bn), the promotion of e-mobility (around EUR 7bn), the modernisation of infrastructure, green building restoration and the promotion of artificial intelligence.

Germany’s Bundesbank published its June 2020 Outlook for the German economy in 2020 and 2021 one day after the announcement of the fiscal stimulus. It has not yet included the stimulus in its projections for growth and inflation, but it assesses that an amount equal to around 1.5% GDP will be spent this year, 0.5% in 2021 and the rest in subsequent years, given that government investment often is implemented with significant delays. The Bundesbank estimates that in 2020, GDP growth could be more than one percentage point higher than its pre-stimulus projections and in 2021, around 0.5pps. That is, if consumers decided to spend all the extra income, and the cut in the VAT rate would also be fully passed on to consumers. We think that the risks to these forecasts are tilted to the downside, as the deterioration in labour market conditions and uncertainties related to the future behaviour of the coronavirus and future household income will probably result in higher precautionary savings and limit the boost to consumption growth. The cut in the VAT rate will also have a significant (yet temporary) impact on inflation. According to the Bundesbank estimates, headline inflation could be around one percentage point lower this year than in its pre-stimulus forecast of 0.8%, implying that the yearly average would fall to levels below zero. (Aline Schuiling)