When Fiscal and Monetary Policies Converge, Markets Can Be Directed
The Final Destination
Yesterday, most stocks saw a decline, with the exception of Nividia which experienced an increase after debunking its Department of Justice subpoena story. Oil prices fell after a failed rally, Treasury yields decreased as the US curve disinverted, and the Japanese yen saw an increase.
The Federal Reserve's Beige Book noted a slight decrease in consumer spending in most Districts. Activity experienced minor growth in three Districts, and remained flat or declined in nine. There were isolated reports of firms only filling necessary positions, reducing hours and shifts, or lowering employment levels via attrition. However, layoffs were rare, wage growth was modest, and input costs and selling price rises were slight to moderate.
Job Openings and Rate Cuts
Attention was drawn to the Job Openings and Labor Turnover Survey (JOLTS) job openings at 7,673K versus the 8,100K consensus, with the last print revised from 8,184K to 7,910K. However, this survey represents just 0.8% of all US establishments, with only one in three of the small number of firms in the survey responding. Moreover, JOLTS relative to those unemployed is now back to where it was pre-Covid, which was considered high at the time.
The Bank of Canada (BOC) cut rates 25bp again to take the base rate to 4.25%, while promising more to come. The Bank emphasized that decisions will be made meeting by meeting and are data dependent. Two opposing forces are likely to impact the policy path: on the upside, shelter inflation and some services; on the downside, excess supply and labor market slack. The same is true in many locations. We expect two more BOC 25bp rate cuts this year to 3.75% by year end, and four 25bp cuts in 2025 to a terminal rate of 2.75%.
Political Turbulence in Canada
In Canada, political turbulence is expected. A federal election is on the horizon in 2025, and Prime Minister Trudeau recently lost the support of the New Democratic Party, which had been helping to keep his minority Liberal government in power. Trudeau will now have to seek new alliances to govern.
Early Voting in the US
In the US, early voting for the 5 November election begins tomorrow. Some voters don't feel the need to wait for the Harris-Trump debate, nor do they need to wait to see if key policy pledges change over time. Yet, Harris is now lowering her proposed capital gains tax to 28%. There could be electoral implications from President Biden's statement that he will block the proposed Nippon Steel takeover of Pennsylvania-based US Steel on national security grounds, especially if, as US Steel claims, jobs in this key swing state are "at risk" without it.
Geopolitical Transformations
With such headlines, it's no surprise that the Financial Times has a feature today on 'How national security has transformed economic policy'. Two things should be noted:
Firstly, this shift was predicted in January 2016. The US-China trade war was flagged a year before it started. The idea of Great Power struggles was discussed in 2018. A 'World of 2030' was projected in 2020. The possibility of Russia invading Ukraine was warned about in January 2022. And the potential for the Suez Canal to be a victim of conflict was flagged 7 days after that attack.
Secondly, this transformation has much further to go. Wars in Ukraine and the Middle East have been transformative there. On Ukraine, obviously; yet Russia is now running a war economy. Israel's finance minister states its war vs. Hamas could cost 13% of GDP – before a potential escalation vs. Hezbollah and/or Iran.
Defence Spending and Geopolitics
Despite constant warnings of the looming dangers of this approach, the US is still seeing real terms declines in its defence budget. The Wall Street Journal now laments 'The US Navy’s Chief Supplier Is in Peril', and that a lack of crew mothballing of 17 sealift support ships will "embolden America’s foes." Supply chains are not just about getting goods to shoppers, but to choppers. The 'geopolitical' bill to do so is going to be enormous.
Germany's Approach to Defence Spending
Germany argues that bridge and highway repairs are defence spending as public roads are used to transport tanks. In July, it declared €91bn in NATO spending, over the 2% target for the first time since the early 1990s. However, only €52bn was assigned to defence in its domestic budget, which included weapons for Ukraine, while much of the rest went on paperwork and pensions.
Fiscal and Monetary Policy Convergence
Moreover, fiscal and monetary policy can converge, and markets can be directed what to do, or to do nothing. If any of the above were to be our final destination, then the market volatility we have seen so far from "geopolitics" is just the beginning. That remains true even if the near-term focus remains whether we see Fed rate cuts, RATE CUTS, or RATE CUTS!
Bottom Line
The convergence of fiscal and monetary policy can have significant implications for the market, especially in the context of geopolitical transformations and defence spending. As the final destination remains unclear, market volatility may just be the beginning. What are your thoughts on this? Do you agree or disagree with these observations? Share this article with your friends and let us know your thoughts. Don't forget to sign up for the Daily Briefing, available every day at 6pm.
