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In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, discusses the import of the last FOMC meeting, expectations around interest rate volatility in 2021, the pending further fiscal stimulus deal, the significance of M2, its velocity and consumers’ “animal spirits,” and the release of the 2021 “Laidlaw Five.”
The topics discussed in this episode are: How important was the last FOMC meeting?, Can we expect interest rate volatility to increase in 2021?, What does the pending fiscal stimulus deal tell us about Congress? What is the significance of M2, its velocity and consumers’ “animal spirits?”, and what can we look for in the 2021 “Laidlaw Five?”
Please tune in for more timely insights.
Hello and welcome to a special episode of “A Brighter Future,” Laidlaw & Co’s Podcast Series. I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and I am joined again today by David Garrity, Chief Market Strategist for Laidlaw & Co.
As I mentioned, this is a special episode this week as in addition to our normal market related topics we will unveil the “Laidlaw Five,” our Top Five Predictions for 2021.
However, before we get to the topic of next year we still have to finish 2020. So to that point, we saw stocks edge higher last week with all major U.S. indexes hitting fresh all-time highs. Fiscal-stimulus optimism, along with a brighter longer-term outlook driven by the rollout of vaccines, continues to support sentiment. Long-term Treasury yields rose modestly while oil logged its seventh straight weekly gain and economic data were mixed, revealing that the economic recovery is losing some momentum amidst rising virus cases and renewed restrictions in activity.
The weakness in retail sales and the recent slowdown in job growth sharpened the market’s focus on fiscal aid and it appears that the Fed and Congress are both focused on the topic.
So David, that’s a lot to “chew on” but I want to start our discussion today on the Fed…
The Fed held their last meeting for 2020, last week and gave us a very clear reading of their objectives going forward – “maximum employment, and inflation at the rate of 2% over the longer run”. They remain committed to a moderate recovery, maintaining their 0%-0.25% accommodative rate, and continuing a substantial QE program to purchase Treasuries up to $80B per month, and MBS up to $40B per month.
So, David, can we assume “the Fed Put” remains firmly in place going into 2021? Also, with a new administration entering the scene after the inauguration in January what, if anything, does that mean to the Fed?
Rick, we were encouraged by last week’s FOMC statement and Fed Chair Powell’s subsequent press conference that sent a clear message to the markets that The Fed will offer increasing levels of support to the economy through its pursuit of quantitative easing. Relative to the change in administration coming next month, we do not anticipate it will have any effect on an institution that is non-partisan and clearly focused on stewarding the economy through its pursuit of the employment and inflation mandates with which it is charged.
David, let’s stay with the interest rate discussion for now as I think most would agree yield curve dynamics will be critical in 2021. While QE kept the yield curve flat at the start of 2020, now with short-term rates pegged near zero, the yield curve slope will be guided by long-term rates. A renormalization in the economy could cause long-term rates to rise from current levels. In fact, after news of vaccine development and strong growth momentum, we have already seen the 10-year Treasury move up almost 50 bps from its summer low to just under 1%.
Over time, long-term rates align with inflation expectations, so it would not be a stretch to imagine the 10-year Treasury testing 2% in the second half of 2021 and I think here is where investors are vulnerable.
Years of historically low rates have caused the duration of traditional indexes to rise. For example, the duration of the Bloomberg Barclays U.S. Aggregate Bond Index (Barclays Agg) is 6.3 years. If the yield on the Barclays Agg rises +100 bps or 1%, it would take almost three years for income to offset the price decline.
So, David, would you expect the continued QE along with speculation about the Fed imposing yield curve control causing unwelcome volatility in a part of most investors’ portfolios meant to be the steadying ballast?
Rick, to our view, The Fed is engaged in a monetary policy of negative real interest rates as it has indicated it will allow inflation to run above its 2% threshold and through quantitative easing that will involve purchasing longer-dated Treasuries serve to cap interest rates at the long end of the yield curve. As we discuss in the “Laidlaw Five”, the yield on the 10-year U.S. Treasury is only expected to rise to 1.5% over the course of 2021 from 0.95% now. So, while the potential exists for there to be volatility in long-term interest rates, we do not see that as happening under the current Fed monetary policy regime.
David, let’s look at a different topic for a few minutes. While no single front by itself can be deemed big enough to derail our economy, there are two in particular that will dictate the pace of the recovery. The obvious first is stimulus package ($900B) given its December 31st deadline, and a not-too-distant second is the initial distribution of vaccines. While Congress can over-ride the deadline with a temporary short-term extension to fund the Government, they cannot over-ride the damage to the consumer if we do not extend jobless benefits or curtail evictions.
We are beginning to see cracks in the fundamental data for November as Industrial Production, Retail Sales, and Housing market Index show some contraction versus prior month data. At the same time, I think we have to remind ourselves, our economic recovery is sustained by consumption, and if our wage earners face possible interruption of their livelihood, they may start holding on to their money. I bring this up as there has been a great deal of discussion about the massive growth of M2, up over +25% year-over-year and in an article I read recently the author reminded us that it’s not the growth of money supply that matters, but the velocity of M2.
First, David, can you explain to our listener’s what M2 is, and, second, what potential effect could there be if the consumer starts holding back spending? It would seem to me no amount of printed money will suffice to compensate for the damage to the “velocity” of economic recovery.
Rick, well I’m glad, but not relieved, to see that Congress is on the brink of approving a further $900bn of fiscal stimulus, an action that will bring the total amount of fiscal stimulus provided to support the U.S. economy through COVID to $3.2tn. I fully expect the stimulus will help boost 2021 GDP growth by +2-3%, but am concerned as the legislative path to get to this package had some indications that the GOP is already seeking to find ways to hamstring the incoming administration in what plans it may bring to further stimulate the economy, namely moves aimed to constrain The Fed’s ability to act.
Relative to the broader monetary aggregates, M2 is all the funds that are covered in M1 (currency in circulation, checkable bank deposits, traveler’s checks) plus savings deposits, money market funds, CDs and other time deposits. M2 is closely watched as an indicator of money supply and future inflation, and as a target of central bank monetary policy. The velocity of M2 is the number of times one dollar is used to purchase final goods and services included in GDP.
Should consumers in the face of COVID opt to reduce spending it will serve to reduce the velocity of M2 and through that mechanism the growth of GDP. The Fed can manage M2 all it wants, but if consumers’ animal spirits are dampened, then other measures are needed to get the economy back on its feet. Which, for example, is why Congress is so important in providing further fiscal support.
David, as I mentioned at the beginning, today’s episode is a special one as we unveil our Laidlaw Five for 2021. We have five (5) topics that we think will impact investors portfolios in the year to come:
There are eight listed below but I think we can combine several to get to our final 5.
1. We think Inflation runs above 2% testing central bank policy.
2. A continued weak USD causes Non-U.S. Equities to outperform SPY/US equities.
3. Given the incredible wealth amassed by Jeff Bezos, we think he may pursue the purchase of at least one major sports franchise.
4. Cannabis is legalized.
5. The exodus from the cities to the suburbs continues, straining budgets and prompting congressional help.
6. Several smaller universities fail and we see the continued adoption of online learning.
7. Markets finish 2021 up +15%, as Fed QE continues.
8. We see a surge in leisure travel in Q2 Q4 as part of the “re-opening trade”/economy continues.
Rick, along with offering up our “Laidlaw Five” forecasts for 2021 in which we have indeed taken the eight items above alone with others and consolidated them neatly into five heading in a longer separate write-up that also assesses how well our 2020 “Laidlaw Five” forecasts fared over the course of a turbulent year that hardly anyone foresaw. I am relieved to say that while we managed to get the general direction of markets right, we did not come anywhere close to anticipating the volatility. That said, we hopefully served to support our clients in building wealth, as is our constant aim. I highly recommend reading the 2021 “Laidlaw Five” forecasts separately.