- A very challenging year ends with positive developments on the Covid-19 vaccine front, but the recent surge in cases has triggered fresh restrictions in parts of the U.S.
- Markets have been well-behaved in the wake of the November 3 election, and the Treasury curve flattened from pre-election levels once a “blue wave” appeared a lesser probability
- The November 5 FOMC minutes included discussion of enhanced guidance for any changes to future asset purchases
We have finally (and thankfully) reached the final month of 2020. This challenging year is ending with encouraging news on the Covid-19 vaccine front. Pfizer and Moderna have both reported trial results that were approximately 95% effective, and as of November 30, both companies have applied for emergency authorization from the Food & Drug Administration. It seems like years have passed since the November 3 election day, and despite the noise surrounding the results, financial markets have responded more rationally (more on this below). Looking ahead to 2021, should we expect more of the same, or will the economic and market landscape materially change? While the vaccine news is clearly a positive, there are still questions regarding the timing, distribution, and usage rate among the population for any approved vaccines. Further, even with a vaccine in place, how long will it take for consumers to return to “normal” habits, particularly as it relates to travel and leisure?
In the meantime, we are seeing record levels of new COVID-19 infections and hospitalizations amid a second wave in Europe and the United States, which is sparking fresh restrictions/lockdowns from various state and local governments. The near-term economic outlook will depend heavily on what, if any, bridge support Congress provides in the form of fiscal aid. Senate Republicans and House Democrats appear unable to reach an agreement in Q4, and as such, economists at some firms, including J.P. Morgan, are projecting negative GDP growth in Q1 2021. Jobless claims rose for two consecutive weeks in November (for the first time since July), and if the November jobs report shows a pause in the labor market recovery, there will likely be increased political pressure on Congress to get something done sooner rather than later. If not, we may hear the phrase ‘double-dip recession’ more regularly in economic forecasts.
As discussed in the November commentary, the yield curve steepening leading up to the election was due, at least in part, to the market pricing a higher probability of a blue wave on election day/week/month. In that scenario, Democrats would have control of both the House and the Senate, which would likely lead to the largest fiscal aid package and potentially an infrastructure spending plan as well. This outcome is still a possibility if Democrats win both Georgia Senate seats, assuming full party-line votes with a tie breaker from the Vice President. However, the bond market is still not pricing in a high probability of Democrats winning both Georgia Senate seats. Once it became clear on November 4 that there would likely be split government, long-end Treasury yields fell, equities rallied, and implied volatility measures for both collapsed from elevated pre-election levels. In this scenario, major policy changes, including taxes, are less likely, and the Biden administration would presumably be less likely to pursue the same tactics on trade policy as the prior administration. The decline in Treasury yields was effectively a correction of the blue wave steepening that occurred leading up to November 3.
Fed Lessons from QE Past
The Federal Reserve has taken extraordinary measures in 2020 to support the flow of credit, including everything from a zero-bound policy rate to asset purchases to municipal and corporate lending facilities. While it would seem there is little left to do, the central bank still has dry powder. The Fed could increase current asset purchases, or it could employ other measures, such as yield curve control. The latter surfaced as a potential option in June. Fed Chair Powell has made clear his opinion that more fiscal support is needed to support the U.S. economy, noting on multiple occasions the limits of monetary policy. The Fed can push interest rates lower and flood financial markets with liquidity, but it cannot subsidize lost wages for individuals or lost revenues for small businesses not able to raise capital in the private markets.
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