Election Economics: Fiscal Frenzy & Market Musings

Much of the focus in financial markets over the past few months has been on the Federal Reserve and forecasts for when they will start to cut interest rates. At Viewpoint, we’ve been keenly interested in the interplay between monetary and fiscal policy, and the implications on the health of the economy. With election year in the U.S. upon us, we expect that fiscal policy will start to play a bigger role in financial market price action. As this Bloomberg opinion article by Claudia Sahm states, the worries around the ever increasing U.S. federal government debt are a bipartisan issue, with both Republicans and Democrats feeling the heat from their constituents. The challenge seems to be that neither side of the aisle can agree on how to tackle this thorny issue. Another recent article from Bloomberg cites former Treasury Secretary Robert Rubin explaining that Republicans don’t want to raise taxes, while Democrats don’t want to budge on entitlements.

If it feels like you’ve heard this before, don’t worry – this is by no means a new phenomenon. While the dangers noted by Rubin in his analogy to the Greek debt crisis may be overblown due to the “exorbitant privilege” of the U.S. dollar being the world’s reserve currency, the federal budget deficit at 6.5% of GDP remains somewhat of a mystery. In Sahm’s opinion piece, she notes that interest payments on the Treasury’s debt as a percentage of GDP are lower than in the late 90s when the U.S. was running budget surpluses. However, with unemployment near all-time lows and the S&P 500 at all-time highs, it doesn’t feel as if there is a dramatic need for fiscal expansion to be supporting an already overheated economy. After a bout of restrictive fiscal policy in 2021 and 2022, fiscal policy added 0.42% to GDP in Q3 and is projected to be relatively neutral in 2024 and 2025. Because of political brinkmanship, we at Viewpoint don’t expect to see any material positive developments on the trajectory of the U.S. debt situation in the short term, particularly during an election year. This means that household wealth will continue to be supported by budget deficits, which will work to keep inflation higher than if fiscal policy was in restrictive territory. As such, we expect that the Federal Reserve won’t be getting much help from the government in the quest to tame inflationary forces, and the glidepath for short-term interest rates is therefore likely to be bumpier than the market is currently anticipating.

At Viewpoint, we are optimistic on the outlook for including government bonds in client portfolios, given elevated yields and the convexity of new issues. But, we also believe that the addition of commodities to a portfolio can help to balance risk exposures in an environment where inflation is unlikely to go back to pre-COVID levels. We feel that the theme for this current cycle will be a continued fight to keep inflation in check, as opposed to the last decade where the fight had been to support economic growth.