Impact of Fiscal, Monetary Policy on Equities and Economy

But those direct transfers to individuals have run their course. The next stage of fiscal policy is uncertain, although likely to contain a mix of multi-year infrastructure projects, some expansion of medical programs, climate initiatives, and tax increases. The positive influence on the U.S. economy is likely to be quite modest due to the nature of the spending and how it is spread over many years. The potential tax increases are unlikely to make much of a difference to business investment or to the economy, but there is a strong possibility that any increases in corporate income taxes will reduce future cash flows and be at least partly reflected in modest downgrades of equity valuations.

Now let’s shift to monetary policy.

When QE or asset purchase programs were first put in place by the Federal Reserve (Fed) in the U.S. as an emergency measure late in 2008 to respond to the financial crisis, there was no historical precedent. We now have 12 years of statistical evidence, and the conclusions contain some interesting elements. QE involving the Fed’s purchase of distressed securities in late 2008 definitively helped to put a floor under the recession driven by financial deleveraging. The QE that commenced in 2010 after the U.S. economy was already growing again was focused solely on purchases of U.S. Treasuries and mortgage-backed securities, and clearly provided support for asset prices, especially equities and fixed-income. What is interesting is that there appears to have been no impact on the real economy or on inflation from the type of QE conducted during times of modest economic growth. This strongly suggests that the withdrawal of QE or tapering of asset purchase programs will have most of its influence on asset prices, and little to no influence on the U.S. economy.

First, the U.S. economy is transitioning from its rapid rebound phase from the pandemic into a much slower, yet positive, growth path as the influence of the direct payments to individuals in the early fiscal policy programs have run their course.

Second, the details of future fiscal policy programs are highly uncertain yet likely to contain a mix of multi-year spending and some tax increases, especially on corporations and wealthy individuals. The multi-year spending on infrastructure is likely to have a modest impact on job creation, while the tax increases may reduce corporate cash flow and be associated with equity valuation recalibration.

Third, the tapering of asset purchases by the Fed is largely expected to be felt in asset prices, as support is slowly withdrawn, and to have little to no impact on the real economy or inflation. We would note that just because an economic event is well telegraphed and widely anticipated does not mean that the reality of the event will not have a big impact over time, just not all at once, as the case with surprises. The withdrawal of QE may be a big deal for equities and bonds when considered over time.