by Greg Valliere, AGF Management Ltd.
WASHINGTON HAS OVER-DONE THE STIMULUS: The most important Fed meeting in years — and the gridlock on Capitol Hill over more spending — will send a clear signal that the pendulum is shifting on stimulus, which has over-heated the economy.
THE EASY CALL IS MONETARY POLICY, which will be reversed today. We expect Jerome Powell will announce that the Fed will end its asset purchases as early as March, with a clear a hint that the first of three rate hikes in 2022 could come by June. More rate increases are possible in 2023.
THE MORE DIFFICULT CALL is fiscal policy, as Democrats struggle to pass the last of Joe Biden’s huge stimulus packages — the Build Back Better bill, which has stalled. The measure hasn’t been fully written yet; there are major differences on state and local taxes, paid leave, and — most importantly — the enormous cost of the bill.
YESTERDAY’S RED-HOT PRODUCER PRICE REPORT may have been the final straw for Powell and Sen. Joe Manchin. Both see an inflation threat that may not subside until well into the second half of 2022. Powell will raise the funds rate; Manchin wants a pause in more fiscal stimulus.
MANCHIN HAS INFURIATED MOST DEMOCRATS, but in truth the party is badly divided on whether to move on BBB or fight instead for voting reform legislation. Both measures may drag into January or later, amid angry calls from the left to change filibuster rules, which were evaded as the debt ceiling was raised. But there aren’t enough Democrats to support a wholesale change to filibuster procedures.
A SKINNY VERSION OF BBB could still pass in early 2022, which would be the last hurrah for fiscal stimulus. The next big development may be a furious effort by Republicans to pare back spending after the 2022 election — as the GOP recaptures the House and perhaps the Senate as well.
AS THE ECONOMY ENTERS THE SECOND HALF OF 2022, it may be clear that the Fed will stick with monetary restraint, while fiscal policy faces a major haircut after the election. Will this be over-kill for an economy that’s likely to soften anyway? We’ve over-done it on the stimulus; could we next over-do it on the restraint?
THE GREAT WILD CARD, of course, is Covid and its variants — which are killing about 1,200 Americans every day. As usual, Europe is the canary in the coal mine, as battles rage between libertarians and vaccine proponents.
OMICRON COULD CHILL ECONOMIC GROWTH here and abroad, as everything from holiday travel to professional sports shut down. But the die will be cast this week in Washington — Powell and Manchin agree that more stimulus isn’t needed; their next battle, belatedly, is fighting inflation.
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This post was first published at the AGF Perspectives Blog.
