Fiscal Cliff & CARES 2 Update- The $600 per week extended eligibility for jobless benefits, payroll protection loans and other assistance programs all worked to support income and spending—both experienced a ‘V’ shaped recovery from the initial wave of Covid. As JPM Morgan CEO Jamie Dimon noted in his earnings call last week, “Savings are up, incomes are up, home prices are up. So you will see the effect of this recession; your just not going to see it right away because of all the stimulus.”
With the end of many programs in sight and deadlines looming as soon as this Saturday, law makers are working to finalize an additional round of economic support. Bloomberg reported this week that Republicans started with $1T while Democrats proposed $3.5T in additional relief. Bill McBride at Calculated Risk noted in order for stimulus to have its greatest impact, first dollar programs should be targeted toward recipients with the highest marginal propensity to consume—folks that need cash to pay bills. That would mean extending Federal Pandemic Unemployment Compensation (FPUC)—at least at some level. Senate Majority Leader Mitch McConnell told reporters Thursday, “The [Trump] administration has requested additional time to review the fine details, but we will be laying down the proposal early next week.” Treasury Secretary Steven Mnuchin told CNBC that the jobless benefit extension will be “based on approximately 70% wage replacement.” That amount could come out to roughly $300 per week for the average worker.
EU Joins the Global Stimulus Efforts. This week a new agreement was reached authorizing the European Commission (EC), the executive arm of the EU, to create a €750 billion recovery fund. Early in the Covid Crisis, Eurozone finance ministers from the 19-country economic block were unable to agree in principle whether to issue joint debt instruments. The agreement now allows the EU to borrow in common and disburse the money where it is most needed. As Rick Rider of Blackrock said this week, “from a policy standpoint, the willingness to functionally mutualize debt through the Eurozone Recovery Fund is a game changer for the region.” Standard & Poor’s added “The establishment of the EW’s coronavirus recovery fund is a breakthrough for the creditworthiness of member states that takes the bloc closer to becoming a fully-fledged fiscal union.” With policy supportive, an improving health response to Covid and more appealing valuations, perhaps Eurozone stocks will begin to respond favorably.
Negative Yields & Financial Repression—Positive for Gold. It may look as though not much has been happening in the 10-year US Treasury yield—it has been ironing-board flat since spring. Did you know that interest rates can be broken down into two different components—a real rate plus an inflation premium? Recently, the inflation expectation component has been trending higher. The Fed is actively buying bonds and positioning future policy actions to control the shape of the yield curve (YCC). Investors, concerned with the long-term economic impacts of Covid, have also continued to buy bonds, keeping rates steady even as government debt issuance increases. That leaves only the real rate to absorb the changes, and it is being pushed further and further into negative territory. Negative real rates create the condition of financial repression which effectively levies a tax to those holding conservative investments.
The combination of negative real rates and high government debt levels has historically been favorable for gold. Gold is viewed as a store of value- a currency with no rate of interest and no central bank. As governments across the world continue to deficit spend and engage in monetary financing of their sovereign debts, gold may continue to rise. A study, produced by Cross Border Capital, tracked the total value of US debt outstanding priced in gold, going back to 1916. Their conclusion? As debt levels rise, the value of gold historically rises as well. Given the rapid debt expansion in response to Covid, gold would (at the time of their study) need to increase about 40% to reach its long-term average.
China- John Authers of Bloomberg reported this week that the current US China relations have reached a point where “Neither side appears to be bothering with diplomatic niceties any more.” Given recent headlines, that appears to be the understatement of the week. As China continues to exercise increasing control over Hong Kong, the Hang Seng remains an important market to monitor.
Social Security Update- The Old-Age, Survivors, and Disability Insurance (OASDI) program annual summary reported its 2019 results earlier this year. The program’s financial condition can be viewed as having one of three basic financial profiles: 1) program costs (benefits) are less than non-interest income (payroll taxes), 2) program costs are less than total income (payroll taxes and interest on reserves) and 3) program costs are higher than total income (requiring all payroll taxes, interest on reserves and depletion of trust fund corpus). According to the report, prior to 2010, Social Security’s cost was below non-interest income (profile 1), and from 2010-2020 costs were (or are expected to be) less than total income (profile 2). Using intermediate cost assumptions, total cost is projected to be higher than total income (profile 3) in 2021 and all later years, depleting 100% of the fund’s $2.89T reserves by 2035. Upon depletion of the reserves, continuing income would be sufficient to pay about 3/4 of scheduled benefits.
How will Covid and the related economic fallout impact Social Security? Three primary ways, all of which put further strain on the program. First, with unemployment rising, payroll taxes into OASDI are falling (payroll taxes are also a source of potential fiscal relief). Second, Social Security claims will increase from workers forced into early retirement. Finally, with short-term rates at 0% and the 10-year Treasury yielding 0.6%, the low rate environment will decrease plan interest income, expediting depletion of reserves. All three of these factors may push OASDI to and through profile 3 and into insolvency sooner than initially expected, barring and legislative action. According to a report by the Bipartisan Policy Center, due to Covid, trust fund reserves could run out by the end of this decade.
I will close here for the week. Have a great weekend.