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Are cracks appearing between central banks and politicians?

20 November 2020

Jonathan Marriott, Chief Investment Officer

During the pandemic, there has been an extraordinary level of fiscal and monetary support for the global economy. Politicians and central banks have seemingly coordinated their response to an unprecedented lockdown. However, as we welcome good news on a potential vaccine, disagreements are emerging that threaten this coordination. Last night, the US Treasury requested that the Federal Reserve return unused funds and proposed closing down several of the support programmes by year-end. In Europe, the latest budget is being blocked by Poland and Hungary. In the UK, the Chancellor is reported to be preparing fund raising measures in his budget on Wednesday next week. Meanwhile the pandemic is far from over and central bankers continue to call for more fiscal action.


Many states are reaching maximum capacity in their intensive care units. They are increasing COVID-19 restrictions. Last night, Treasury Secretary Steven Mnuchin asked for the return of funds from the Federal Reserve and called for the end of the corporate bond buying programme on 31st December. He is also looking to end the Municipal Liquidity Facility, Main Street Lending Program and the Term Asset-Backed Securities Loan Facility. These measures have helped to keep the credit markets functioning and potentially prevented a wave of bankruptcies. However, the Federal Reserve wants to keep all its options open and is objecting to this request. Before the election, the dispute between the Republicans and Democrats had narrowed and a deal on a near $2 trillion package looked close, but failed to pass. The focus now is agreeing a spending bill to avoid a federal shutdown on 11th December. Mnuchin is talking of redirecting $580 billion of unused stimulus from the Federal Reserve. There appears to be no talk of a stimulus package on the scale proposed before the election. As cases rise, President Trump's attention is focused on making legal challenges to the election that at present appear to have little chance of success.


European Central Bank President Christine Lagarde says they are ready to do more on the monetary front, but has repeatedly called for greater fiscal stimulus.  The European Union appeared to have agreed a €750 billion pandemic recovery package with funding from loans issued centrally by the EU. However, the details continue to be debated, thus delaying implementation, and the latest EU budget has been blocked by Poland and Hungary. The EU structure that requires agreement of all states on many issues is once again impeding progress. Brexit talks have been suspended because a member of Michel Barnier's team has tested positive for COVID-19, but, if a deal is agreed, it will need approval by each individual state, which may yet prove problematic. 


The Chancellor will be making a budget statement on Wednesday. As has been common practice in recent years, many of the proposals have been floated before the statement. This morning, there is talk of a pay freeze for the public sector, excluding the NHS. There has also been talk of equalising the rate for Capital Gains Tax and Income Tax (see our other article in this week's The Brief) and we have seen suggestions of revising Inheritance Tax.  A long-term review of the Retail Price Index (RPI) has been ongoing and it may be moved closer to the Consumer Price Index (CPI-H) or abolished. Index Linked Gilts are based on RPI so a move to CPI, which has generally run about 1% lower, could save funding.  Meanwhile, Boris Johnson has announced increased spending on defence and the environment. The Bank of England has contemplated more measures, and even negative interest rates, and are calling on the Government to provide more stimulus. The Chancellor needs to be careful that tax rises are not premature and do not slow recovery. The best way to repay the debt incurred during the pandemic is to grow the economy rather than raising taxes. 


Following the news of a vaccine last week from Pfizer/BioNTech and this week from Moderna, there is light at the end of the tunnel. We have also seen positive news on the Oxford-AstraZeneca vaccine. The first two vaccines should move forward for approval in mid-December and others may follow in the new year. Manufacturing and distribution will take time and it may be mid-2021 before it becomes widely available and some people may have to wait until the end of 2021. In the meantime, the virus spreads and measures to counter the pandemic may be in place in one form or another for much of next year. We need a continuation of the coordinated support both fiscal and monetary to counter the economic impact. It is too early to be tightening conditions and political infighting is not helpful.

Splits between central bankers and politicians are normal and ultimately we are likely to see further stimulus. In the US, this may have to wait for the new administration. In Europe, they will eventually find a compromise – they usually do at the last minute. In the UK, Chancellor Rishi Sunak will no doubt have to tread a careful path, with Brexit continuing to complicate the outlook.

Markets have responded positively to the vaccine news with many of the most beaten-up stocks recovering sharply, however, some of the steam has come out of these stocks as the time for vaccines to be delivered becomes apparent. The failure of knitwear retailer Jaeger's parent company reminds us that many companies, particularly in the retail sector, have been hit hard. Stronger than expected UK retail sales this week reflect online activity rather than the high street. As long as pandemic restrictions apply, cash depletion continues for companies whose activities are restricted or closed by the pandemic. This will see corporate debts rise in these areas, compromising long-term growth. As a result, low interest rates and other forms of economic support may still be needed even after vaccines become available. This will not only support struggling companies but will support the wider financial markets.

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