Macro update: US politics; Fed; European responses to Corona

Advantage Biden

Some good news at last. The moderate Joe Biden largely won the Super Tuesday primaries in 14 US states. He is now the clear favourite to clinch the Democratic nomination. That reduces the tail risk that the self-styled “democratic socialist“ Bernie Sanders could be the party’s nominee. Biden is now ahead of Sanders with 438 to 369 delegates as of 7am London time (www.electionbettingodds.com attaches a 73% probability to Biden winning the Democrats’ presidential nomination). Expect the other moderate, Mike Bloomberg, to support Biden eventually. Biden can also count on most of the “super delegates“ to be selected by the mostly moderate party establishment.

In my view, a moderate like Biden should have at least an even chance to beat Donald Trump on 3 November. At least as importantly, his nomination instead of having Sanders as the candidate could help the Democrats to maintain control of the House of Representatives. That would contain the impact which a re-elected Trump would have on some key policy areas.

For a thorough assessment of the candidates’ economic platforms, see here. For a summary and highly stylised look at the consequences of potential US presidential and congressional election results, see here.

The Fed: a questionable move

Doing too much of a good thing can backfire. By cutting rates by 50bp instead of 25bp and by doing so at an emergency meeting instead of a regular one, the Fed yesterday combined two unusual things in one go. As that looks overdone relative to the coronavirus challenge facing the US so far, markets reacted badly, wondering whether the Fed may know something bad which others do not and what the Fed could do next.

Confidence matters in volatile times. It would have been better for the Fed to cut by 25bp and let markets hope for more. Still, we find the market reaction far overdone. That the Fed knows something really bad which markets do not seems highly unlikely. Also, the Fed is not out of ammunition and the cut in rates may still have some modest positive effect on the real economy over time. Of course, the onus to act is now even more on fiscal policy in the US. See also Mickey Levy‘s assessment (attached) of the Fed move.

The likely UK response

We now expect the BoE to cut the bank rate by 25bp to 0.5% at its upcoming 26 March meeting. It may even signal that it could begin to buy bonds with a focus on corporate bonds if economic risks increase further. The adverse market reaction to the Fed‘s emergency cut argues against an inter-meeting move. In addition, expect UK Chancellor Rishi Sunak to announce a series of emergency measures at the upcoming 11 March budget to help households and firms hurt by the virus disruptions. The measures likely will be focused on maintaining employment and incomes through tax breaks and direct subsidies - see Kallum Pickering‘s in depth analysis of the likely UK response.

The potential ECB response

The ECB will most likely react to virus epidemic as well. But unlike the Fed and the BoE, the ECB has limited room to act as its key rates are already at zero or negative and it is facing a dearth of investible sovereign bonds under its current rules. Cutting the deposit rate from -0.5% to -0.6% and injecting more liquidity into a system already awash in cash would not make much of a difference. We thus see only a 40% chance for a 10bps cut in the deposit rate on 12 March. Instead, we expect the ECB to announce some targeted measures such as new generous liquidity injections or re-financing facilities for banks aimed at keeping liquidity flowing to small and medium-sized businesses. The ECB could also tilt its bonds purchases more towards corporates, possibly raising the amount of monthly bond purchases temporarily. If the ECB were to cut the deposit rate, it would make the tiering system more generous for banks at the same time. For more, see Florian Hense‘s analysis.

A Eurozone fiscal response

Due to the powerful automatic stabilisers in Europe’s highly developed welfare states, the need for a discretionary fiscal boost is less pronounced. Of course, there may still be some need for additional fiscal support to help the areas of the economy facing the most stress. Health spending will be raised; affected countries such as Italy will be given the leeway to miss fiscal targets by more than usual and governments will offer support to temporarily struggling companies and citizens. In addition, we expect modest fiscal packages that go beyond the gradual easing of fiscal policy that is already underway in Germany and many other Eurozone countries.

The German angle: Even pre-corona, Germany was on track to ease fiscal policy by c0.4% of GDP this year as part of an ongoing multi-year slow-motion stimulus. This will now likely be scaled up slightly. Although there is still resistance in the centre-right CDU to more fiscal easing, the coalition will likely agree some combination of modest tax relief for businesses and more spending soon. A modest package could perhaps even include accelerated depreciation allowance to bring business investment forward in time. Germany‘s biggest automatic stabiliser, the Kurzarbeitergeld scheme could also be made more generous.

As public investment is mostly supply constrained (not enough workers, long planning procedures), it is difficult to raise it. One smallish measure to help would be to shift debt of highly indebted municipalities to the federal level to allow the few municipalities which are cash-strapped to spend more. Such a debt shift would require a temporary suspension of the debt rule for the federal government, not the overall government sector. Finance minister Scholz has been advocating that for a while.

Holger Schmieding
+44 7771 920377

Kallum Pickering

+44 20 3465 2672

Florian Hense

+4420 3207 7859

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