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Jeff Meli Ajay Rajadhyaksha

Episode 30

Jeff Meli in conversation with Ajay Rajadhyaksha

Does the US need another round of fiscal stimulus?

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The US economy has delivered a series of surprises to the upside, despite significant challenges caused by the global pandemic.

US unemployment rates are now below seven percent and quarter-over-quarter annualized growth was 33% in Q3. With the US economy improving, and elections failing to produce a ‘blue wave’ mandate in Congress, the size and type of any additional fiscal stimulus is up for debate.

In the latest episode of The Flip Side, Head of Research, Jeff Meli, and Head of Macro Research, Ajay Rajadhyaksha, discuss whether factors such as the distribution of the recovery to date, the appetite for increasing national debt and the looming possibility of a vaccine warrant further fiscal stimulus to bolster economic recovery in the US.

  • Jeffrey Meli: Welcome to The Flip Side. My name is Jeff Meli. I'm the Global Head of Research at Barclays. I'm joined today by Ajay Rajadhyaksha, our Head of Macro Research. Thanks for joining me, Ajay.

    Ajay Rajadhyaksha: Thank you for having me, Jeff.

    Jeffrey Meli: In this episode, we're going to talk about what type of fiscal stimulus might be required to help the U.S. continue its economic recovery. We're now several days past the election and there's still some uncertainty about the results. But one of the things that we do know is that a blue wave did not materialize.

    That throws into doubt the prospects for a massive new round of stimulus, which I think would have been priority number one for the Democrats if they had retaken the Senate. The House had been pushing a bill sized well over $2 trillion before the election just to give an example of what the Democrats were thinking.

    But with Republicans likely to hold the Senate, it's unclear at this point what bill would get passed. There is support for doing more, but it's almost certainly going to be substantially smaller. And at the same time, the economic recovery continues to have momentum despite surging case loads here in the U.S. as well as abroad.

    Ajay Rajadhyaksha: Look, the economy definitely does have momentum. At the worst of the crisis, you remember when we were in something approaching a national lockdown forecasts consensus views were for the U.S. jobless rate to peak about 20 percent to be about 10 percent even by year end and instead we are already below seven. And this is despite a second COVID surge in the summer, a third COVID surge like you said that is occurring right now.

    Look at the economic surprise indices for the U.S., all it shows is upside surprises for the last several months. The labor market, consumption, housing everything has done better than expected and it's not even just the U.S., the euro area grew at almost 50 percent quarter-on-quarter annualized in the third quarter. The global economy led by the U.S. is just bouncing back faster than anticipated.

    But here's the thing, Jeff, part of the reason the economy has momentum is precisely because of the massive stimulus efforts that western policymakers put in place this summer.

    Jeffrey Meli: Well, I agree that stimulus has helped the recovery, but look at how much momentum the economy has now, I'm just not sure we need yet another round of spending. We haven't had additional federal spending for the past two months, yet the Q3 growth numbers were eye-popping. The U.S. grew 33 percent quarter-over-quarter annualized.

    Ajay Rajadhyaksha: I disagree about the need for another stimulus. I think the economy would benefit from another bill and that bigger is better. Don't get fooled by the recovery, so far, it is impressive. But like I said it has been fueled by fiscal stimulus throughout the developed world and that is starting to wane everywhere. Now is not the time to let up.

    Jeffrey Meli: I think that's an interesting perspective, Ajay, because you have to admit, we have recovered so far so fast, that 2020 might end up looking more like a normal recession, not the total disaster scenario we were envisioning earlier in the year.

    Ajay Rajadhyaksha: That is true, but there are two reasons why I think it's the wrong perspective. One refers to the distribution of the recovery and the other is about the potential that things could get worse from here on. So on the first topic, we are experiencing what I think of as a K-shaped recovery, which means that some sectors have bounced back fully or are even stronger than pre COVID, but others continue to be under extreme pressure.

    If you have a white collar job, if you can work from home, you are probably doing fine not just in terms of employment, but especially in terms of wealth as house prices and stock prices are all up. But if you work in certain sectors; restaurant, travel, leisure, entertainment, you have not participated at all in this recovery.

    Jeffrey Meli: Well, the recovery has left certain sectors behind. But I don't understand why the composition rather than the magnitude of the economic pain is important when considering further stimulus. So you seem to be suggesting this version of 6 percent or 7 percent unemployment is somehow worse than the same level of unemployment in other recessions, when it was distributed differently throughout the economy.

    Ajay Rajadhyaksha: I am suggesting exactly that and it is because this recovery to date has been all or nothing. In normal recessions, while there may be sectors that do better or worse, the pain is pretty widespread, but because of the concentrated nature of the implications of COVID, because it hurts social engagement dependent sectors so hard, we may be under estimating the extent of economic distress in some areas.

    For example, even as the jobless rate has come down, the ranks of people who consider themselves permanently unemployed is now at an all-time high. The prospect that the recovery naturally and eventually extends to these sectors and people before a vaccine is low and even after a vaccine, the damage could take a while to repair.

    Jeffrey Meli: Well, again, there is no doubt that the remaining economic damage is highly concentrated. I just don't get the link to stimulus. How does additional mega federal spending help? It's not like all that stimulus is going to get restaurants open or concerts or plays restarted. We're getting folks flying on airplanes and staying at hotels again.

    Ajay Rajadhyaksha: I agree that some of these sectors will struggle until a vaccine, but we are not that far away, especially with the news that has come out recently. We know that a number of companies are in Phase III trials. These trials for infectious diseases have 85 percent chance of approval and we now know that Pfizer's vaccine has a 90 percent efficacy rate. That's a big deal.

    It means we could reach herd immunity far more quickly. But until that happens, these folks need to be kept afloat, businesses in these sectors have to be kept alive until such time as we approach near normalcy. Otherwise, Jeff, you will have hundreds of thousands of new bankruptcies from small businesses and you will get more permanent economic scarring.

    Keep in mind, the whole goal of the stimulus effort was precisely to keep the economy afloat until such time as near normalcy returned. So income replacement, loans to small businesses, that's the kind of thing you spend the money on, not (shovel ready) projects.

    Jeffrey Meli: All right. Ajay, I think you're making a strong case for some targeted stimulus. For example, an extension of the PPP program, but focused on specific industries. That was where the federal government gave forgivable loans to small businesses that were impaired by COVID, but conditional on them spending the money on certain expenses like rent and wages.

    There's also a case for extended unemployment benefits, since people who work in the industries that are most constrained simply have few job prospects. You could target when those rolled off to be coincident with when we expect a vaccine to be more widely available. But combined those types of programs only add up to a couple hundred billion dollars. It's not even close to the $2 trillion or $3 trillion size that has been floated.

    I actually think there's a risk that if we spend too much, we exacerbate the K-shaped nature of the recovery. So for example, imagine we sent every household another stimulus check, like we did in some of the earlier stimulus, programs. Given a surging virus, it's unlikely you're going to spend that money at a restaurant or in travel, instead you're more likely to do something like go shopping online.

    But ecommerce companies have already been benefiting through the COVID experience, all you would be doing with that money is piling on and exacerbating some of the constraints that you're talking about.

    Ajay Rajadhyaksha: So I sympathize with you, Jeff, about the argument about targeted stimulus. But that's exactly why the rest of the focus should be on state and local governments, whose budgets have been hit very hard. This is an economic decline in waiting. Municipal budgets are adjusted with a lag and although we know that their finances are already in terrible shape, it hasn't yet resulted in layoffs and lower services but it will happen.

    We know this from the experience through the financial crisis and these layoffs linger for years. People lose job skills and it ends up becoming a permanent economic drag. A new stimulus will go a long way towards preventing that.

    Jeffrey Meli: One reason I'm doubtful of the need for so much state and local aid is that like with the worst of the economic forecasts that you referenced earlier, the worst forecast for how poorly municipal budgets would fare have also proven too pessimistic. So a lot of local revenue is driven through property taxes, housing prices have actually risen through the pandemic, not fallen, high savings rates, low interest rates, they've led to a surge in home buying that's raised home prices, so that part of the tax base is doing just fine.

    The labor markets recovering now, too. That means we don't see that much risks for a wave of bankruptcies that would affect home prices. We also think that income tax receipts will end up falling by less than we anticipated earlier on, when we thought the unemployment rate was going to peak over 20 percent. So the situation may not be that dire overall and therefore doesn't really require this massive new round of spending.

    Ajay Rajadhyaksha: So that may be true for a lot of the smaller municipalities, especially the suburbs. But the strain on big cities is more severe and we know that urban centers are more important drivers of economic activity. Further there is concentrated budget stress on areas that are important to an eventual recovery, like mass transit in many of these bigger cities.

    Jeffrey Meli: OK. Look, no doubt big cities are under more budget pressure than smaller localities or the suburbs. I'm not sure why it's necessarily appropriate for the federal government to step in though in those cases. So let's take an example here in New York City, the budget shortfall could be as large as 10 percent of total revenue.

    Now, for contacts, that sounds like a big number. But if the budget shrank by that much, it would just take total spending back to where it was three or four years ago. So in those three or four years, New York City was literally booming. It had an amazing increase in tax revenue, most of which got spent.

    Now, there's a downturn and what you seem to be saying is that it's somehow the responsibility of federal taxpayers to step in to maintain peak New York City spending.

    Ajay Rajadhyaksha: Look, I'm not saying that but should we just accept the economic damage that will come with these strains on big cities? Are we supposed, for example, to let transportation systems weather and do nothing about it?

    Jeffrey Meli: No, I think you're making a good point about mass transit. I think there's a big difference, though, between supporting some key infrastructure that has very clearly been impaired by COVID and making whole municipalities who have been flush enough to increase their budget by 10 percent or 15 percent over the past four years and now have to tighten their belts somewhat.

    Ajay Rajadhyaksha: A lot of your arguments, Jeff, do rest on the current momentum of the economy and yes, that is admittedly strong. But we need to look forward to the next few quarters and recognize that the COVID situation is now getting dramatically worse, exactly as many experts predicted.

    Jeffrey Meli: Well, Europe is certainly experiencing a very significant second wave and the aggregate numbers in the U.S. are high too, although within the U.S. there's a lot of regional variation.

    Ajay Rajadhyaksha: Yes, I'm glad you mentioned Europe. The situation on the continent and in the U.K. is pretty dire. Right now, new daily COVID cases in the EU are running at over 200,000 a day. COVID-related deaths are running at 3,000 a day. Lockdowns have been already reinstated in many parts of Europe, but that does mean that the euro area, our largest trading partner, is about to go from a very strong Q3 to a negative Q4.

    Official after official has warned about the fall, being the worst time from – about – when it comes to COVID right from the middle of the year. And the cases in the U.S. continue to set records too. As you mentioned, some regions like the Northeast have managed better, but even in New York City, which has been very careful, the numbers are starting to go up.

    Also, winter will make certain economic workarounds like, say, outdoor dining more difficult. We are setting ourselves up Jeff for losing the economic momentum we have and think of additional stimulus perhaps as an insurance against this.

    Jeffrey Meli: Look, the rise in caseloads is scary. The U.S. numbers are bad enough, but as you mentioned, Europe is really struggling. I just don't think we should draw such strong links between COVID cases and the economy. I understand that when COVID first came on the scene, that was the case.

    We went through a similar rise in the case load in the U.S. during the summer and economic activity didn't take a hit. Actually, the recovery gathered steam. I don't see a scenario where the U.S. re-enters mass lockdowns and therefore links COVID to the same kind of economic damage.

    Ajay Rajadhyaksha: So let's look at the numbers. U.S. cases are at all time highs now at over a hundred thousand a day and heading higher. I think you might still be right, by the way, about no widespread lockdowns in the U.S. But Jeff we also thought new lockdowns in Europe were very, very, very unlikely until they happened.

    Part of the problem is that in the winter we do have two respiratory illnesses flu and COVID interacting together and making things worse. And that is why scientist after scientists has warned about what happens in the winter for the last six months. And that is also why every Fed official, Chairman Powell, Governor Brainard, all of them are pushing for new U.S. fiscal stimulus.

    Jeffrey Meli: Ajay, one thing we haven't talked about is that we have to be able to afford all this spending. As it is, COVID is going to lead to an extra $5 trillion to $6 trillion in U.S. deficits over the next two years relative to what we would have had without COVID. At what point do we draw the line? If we spend the money now, in anticipation of this future economic distress, that may not even happen, are we using a bullet that we might regret in the future?

    Ajay Rajadhyaksha: Come on, we passed a corporate tax cut that took our deficits from half a trillion to sustainably over a trillion at a point when the jobless rate was below four. And that was during the peak of the economic expansion. Now, the unemployment rate is near 7 percent is now the time that we start worrying? Even now despite the impressive labor market recovery, more than 10 million fewer people are employed than in early 2020.

    I'll also point out that the lesson from the Trump tax cut is that the economy does respond to this type of stimulus. We do get a boost to unemployment. The labor force participation rate continued to improve after the Tax Cut and Jobs Act was passed.

    And at a time where a lot of economists, remember at that point thought we were pushing on a string. So even if you are right, that the (court-driven) pain doesn't cause further economic damage, I would say there is still cause for further spending.

    Jeffrey Meli: OK. I don't deny that we benefited from the Tax Cut and Jobs Act which was the official name of the Trump tax cuts in terms of a boost to the economy. I do think that it's unclear whether those gains were worth the cost. Like you said it came at significant increase to the deficit. More importantly, we also have way more debt now than we did then. There does exist a limitation on how much deficit spending we can do.

    Look, we don't know exactly where that is and almost surely the U.S. has further room for deficit spending from where we are today. Ultimately, that debt needs to be financed. Eventually, even in a period where interest rates might be rising, there is a limit out there, we don't know how big it is, but if we use it now, it's not going to be available in the future.

    Ajay Rajadhyaksha: So I don't think that limit, that constraint is anywhere near as large as people worry about, especially given how low rates are and you also have to consider a counterfactual. There is a cost potentially to not doing anything more. But let's stay on the topic of the limit, 10-year U.S. Treasury yields are currently below 1 percent even with news of a Pfizer vaccine (baked in).

    In more indebted countries like Italy, 10-year sovereign debt yields are currently between 75 to 80 basis points. These are not markets that are worried either about existing debt levels or the prospects of more to come.

    Jeffrey Meli: Well, we'll continue to cover that developing topic. Thanks, Ajay, for joining me for this episode of The Flip Side.

    Clients can read our latest reports on these topics, including “A successful vaccine should not dampen stimulus hopes” available on Barclays Live.

Authorised clients of Barclays Investment Bank can log in to access related reports on Barclays Live:

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About the analysts

Jeff Meli is Head of Research within the Investment Bank at Barclays. Jeff joined Barclays in 2005 as Head of US Credit Strategy Research. He later became Head of Credit Research. He was most recently Co-Head of FICC Research and Co-Head of Research before being named Head of Research globally. Previously, he worked at Deutsche Bank and JP Morgan, with a focus on structured credit. Jeff has a PhD in Finance from the University of Chicago and an AB in Mathematics from Princeton.

Ajay Rajadhyaksha is Head of Macro Research at Barclays, based in New York. He oversees the global research and strategy efforts of the economics, rates, FX, commodities, emerging markets, securitised, and asset allocation teams. Since joining Barclays in 2005, Ajay has held various positions, including Co-Head of FICC Research and before that, Head of US Fixed Income Research and US and European Securitised Research.

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