As President Trump’s trade policies slow global economic growth, the ability of central banks to effectively respond is being called into question, leaving financial markets to price in the chances for government fiscal policy to save the day.
A growing number of market commentators say the case for fiscal stimulus is strengthening in the U.S. and the eurozone. However high government debt, budget deficits, and a lack of political will may limit how much politicians can prime the pump in the event of a sharp economic slowdown.
“A tangible shift can be detected as regards the usage of fiscal policy with debates in the U.S. as well as Europe becoming more prominent,” wrote Peter Schaffrik, global macro strategist at RBC Capital Markets.
But he warned that investors shouldn’t look forward to prompt action and even if politicians managed to gather their resolve and make space in government budgets for increased spending, “it is likely to be too small in itself to change the market themes of a slowing economy.”
All the same, markets are increasingly sensitive to talk of fiscal stimulus spending as trade policy tensions continue to rattle investors. Historically low interest rates globally, plus low inflation, could mean there is more fiscal space than in past slowdowns, analysts believe.
Last Monday, European equities surged after German finance minister Olaf Scholz suggested the deficit-averse government was finally warming up to the idea of deficit spending, suggesting it could deploy €50 billion ($55 billion) of stimulus.
Arnim Holzer, a portfolio manager at EAB Investment Group, said the prospect of fiscal easing may be one reason why the S&P 500
index is still up more than 14% year-to-date, only a few percentage points away from its all-time high, despite the tide of worrisome import tariffs announced since last week.
“Are equities incorporating fiscal support?” asked Holzer.
So far, stock-market investors have mostly looked towards central banks for support, even though monetary policy makers question how much more they can do given zero or negative interest rates and bond buying in recent years.
At the Federal Reserve’s annual Jackson Hole Symposium in Wyoming last weekend, Fed Chairman Jerome Powell said that monetary policy had no established rule book to deal with trade protectionism of the kind being implemented by President Trump.
As a result, some say governments will have to step in to prop up economic growth as import tariffs disrupt business supply lines and freeze capital investment. In the U.S., even though Trump has claimed that China is bearing the cost of his import tariffs, fears of a recession before the 2020 elections have resulted in the White House discussing payroll and capital gains tax cuts.
“It’s an uphill battle the Fed is fighting at this moment,” Jody Lurie, corporate credit analyst at Janney Montgomery Scott, told MarketWatch. “Anything that gets done on the monetary policy front is going to going to be overshadowed by anything done on fiscal policy,”
Yet the U.S. may not have much room to engage in extra government spending as it deals with the reality of trillion dollar deficits following the 2017 Tax Cuts Joint Act, according to Bob Schwartz, senior economist for Oxford Economics. The U.S. federal budget deficit was already running at 3.8% of GDP last year and is projected to rise to 5.1% of GDP this year.
“The answer to all this debt isn’t more debt,” Nick Maroutsos, co-head of global bonds at Janus Henderson Investors, told MarketWatch.
Expectations for more deficit spending in Europe remain muted, too.
Aline Schuiling of ABN Amro says the eurozone’s strict fiscal rules mean investors shouldn’t get their hopes up.
Economists at the Dutch bank say an extensive fiscal stimulus package could lift the eurozone GDP by 0.75 percentage points, but that it remained unlikely because of the European Commission’s rules limiting annual budget deficts and debt levels.
Still, Thanos Bardas, co-head of investment grade at Neuberger Berman, said the clamor for more deficit spending was understandable. The lack of a sustained recovery in the eurozone after the debt crisis of 2012 illustrated how monetary and fiscal policy had to be used in conjunction.
On its own, the European Central Bank’s interest rate cuts and asset purchases helped to ease financial conditions but did not deliver the solid economic growth that the U.S. saw after the 2008 financial crisis, he said.