The S&P 500 reached new all-time highs in August (3,508) driven by the Information Technology sector and the dovish change in the Federal Reserve’s policy formulation
Global equities rose significantly in August due to a stabilisation in US epidemiological data, optimism that at least one Covid-19 vaccine will be approved by the end of 2020, continuing positive surprises in Q2 corporate results and abundant liquidity, along with central banks aiming to keep interest rates at low levels for a considerable time (see graph below). Overall, the MSCI ACWI was up by 6.3% in August with the S&P500 over-performing (+7.2%), led by heavyweight Information Technology stocks (+11.4%). Corporate bond spreads were broadly unchanged with the exception of EUR Speculative Grade bonds gaining c.2% in total returns. Core bond prices slipped as increased investor appetite and higher inflation expectations led interest rates 10-20 bps higher in the main markets with the 10-Year US Treasury yield at a two month high of +0.75% following the Fed’s framework review announcement (see below). Finally, gold prices ($1,965) and the EUR ($1.19) remained broadly flat in August, albeit having appreciated significantly since end-March ($1,578 and $1.10, respectively) partly in response to the Federal Reserve’s ultra loose monetary policy on the one hand and positive political developments in Europe (Next Generation EU fund) on the other.
On Thursday, at this year’s (virtual) Jackson Hole research symposium, Fed Chair Powell announced the results of the central bank’s monetary policy framework (MPF) review. The FOMC revised its official statement on policy goals in order to safeguard the 2% long-term inflation expectation and promote maximum employment. In the details, (i) The FOMC will replace flexible inflation-targeting with one-sided average inflation targeting (AIT), which only aims to restore inflation to a 2% average when it has been below 2% for a considerable period of time (not specified). As a result, any appropriate monetary policy is likely to endeavour to achieve inflation moderately above 2% for some time following periods when inflation has fallen short of that goal. Note that core PCE inflation, the Fed’s preferred measure, has averaged +1.6% over the last five years (see graph below); (ii) On maximum employment, appropriate monetary policy will now be informed by the Fed’s “assessments of the shortfalls of employment from its maximum level” instead of “deviations from its maximum level” suggesting that employment can run at or above the real-time estimates of its maximum level (current estimates of u*: +4.1%) without causing concern. As a result, the likelihood of any proactive interest rate hikes in order to prevent a “tight” labor market from getting “tighter” is negligible as inflation appears to be considerably less responsive to activity gaps - a flatter Phillips curve. All told, the MPF review confirms the Fed maintaining a lengthy period of zero interest rates.
On the US fiscal policy front, although an agreement was not reached before the legislature’s summer recess, negotiations are effectively continuing: the vast gap between the Republicans’ proposal (worth $1 tn or 4.7% of the US' GDP) and the respective proposal from the Democrats (initially $3.4 tn or 16% of the US’ GDP) appears to be lessening, with Pelosi (Speaker of the US House of Representatives and Democratic Party member) having cited that the Democrats’ proposal could be halved. Nevertheless, it should be noted that an agreement being reached on large size spending bills just a few months before the Presidential elections (in November) is politically convoluted. As a result, the possibility of a relatively smaller spending bill being agreed upon at the current juncture, leaving the door open for more stimulus after the November elections, cannot be ruled out.
A fiscal cliff in the US due to the July 31st expiration of the Federal Pandemic Unemployment Compensation (an additional $600 per week benefit for those eligible for unemployment insurance) was partly avoided for the time being. Indeed, via respective Presidential executive orders, additional unemployment benefits are to continue, albeit lowered to $400 per week for those receiving at least $100 per week in regular benefits. Individual States will cover 25% (allocations from the $150 bn Coronavirus Relief Fund can be used) while the federal government will cover the remaining 75%, funded by the $44 bn from the Disaster Relief Fund. Assuming that unemployment insurance claims (including regular State programs and newly introduced programs due to the pandemic) run at c.27 mn (vs. 28 mn in the final week of July), the federal share for the additional benefits would cost c.$34 bn per month. This would result in the $44 bn in resources running out in early-September, thereby pressuring the US legislature to reach a deal on a new stimulus package. Another major fiscal deadline is September 30th when the federal fiscal year ends, given that without a new spending bill, a partial federal government shutdown would take place as of October.