Why fiscal stimulus is the only game in town

Risk assets have been remarkably resilient — largely because investors expect greater even greater fiscal stimulus and ongoing support from monetary policy

UBS Australia chief economist George Tharenou: ’Fiscal policy still has scope to support the economy more than previously flagged.’ Picture: Hollie Adams

Risk assets have been remarkably resilient in the face of worsening coronavirus trends, US fiscal policy inertia and a new low in China-US diplomatic relations, largely because investors expect greater even greater fiscal stimulus and ongoing support from monetary policy.

In that environment, UBS Australia’s institutional clients are “too scared” not to have exposure to equity and corporate bond markets, the Swiss investment bank’s head of capital markets ANZ, Richard Sleijpen, said in a half-year review and outlook of the economy and financial markets.

Shares gave up gains last week after tit-for-tat US-China consulate closures, higher-than-expected US jobless claims data, and worsening coronavirus trends in the US, Australia and elsewhere.

But after starting the week on the back foot, Australia’s S&P/ASX 200 benchmark rose along with US index futures, after White House officials said they had an in-principle deal on a $1 trillion ($1.4 trillion) phase 4 coronavirus relief package that will contain extended unemployment benefits, even though another fiscal package of at least that magnitude has been expected by markets for weeks.

Spot gold surged as much as 2.2 per cent to a record high of $US1944.71 per ounce, but with the US dollar simultaneously dropping sharply to its lowest in almost two years, the strength in gold at this point has more to do with record low interest rates in the US, rather than safe-haven demand to hedge against multiple potential risks.

Earnings reports and outlook statements from US industrial heavyweights 3M, UPS and Caterpillar, tech mega-caps including Facebook, Apple, Amazon and Google, and ASX-listed companies including Rio Tinto and Unibail-Rodamco-Westfield are due this week, along with US GDP and China PMI data, but US fiscal developments and the Federal Reserve statement early Thursday could well be more important for markets given the overwhelming influence of unprecedented stimulus since March.

Even after the Australian government last week projected a record $184.55bn budget deficit for 2020-21 following its addition of $20bn of new stimulus last week, UBS Australia chief economist George Tharenou says the looming $80bn “fiscal cliff” will still need to be addressed, particularly in light of the second wave of COVID in Victoria which also threatens to take hold in NSW.

“Critically, fiscal policy is strongly supporting the economy, and debt remains lower than overseas, seeing rating agencies affirmed the AAA sovereign credit rating,” Tharenou says.

“Hence, fiscal policy still has scope to support the economy more than previously flagged.

“Furthermore, government comments indicate further fiscal support will likely be included in the ‘full budget’ on October 6, as part of a broader reform package and jobs recovery plan.”

Tharenou says a further extension of JobKeeper and JobSeeker until mid-2021 is the most obvious policy choice, particularly if the jobs market is as weak as the Treasury forecast of a sharp rise to 9.25 per cent this year before remaining around 9 per cent next year.

But even with such an extension, he expects the payment rates and thresholds for those schemes to be tapered again, resulting in an additional cost to the budget of $10bn to $13bn.

Tharenou also feels there’s almost certain to be further support for business to encourage investment, which is collapsing to the lowest ever share of the economy, and he notes that another investment tax break/allowance has been flagged, while a corporate tax rate reduction for medium-sized businesses could re-emerge as a longer-term reform option.

The first of the next two phases of personal income tax cuts — already legislated for mid-2022 and mid-2024, worth $14bn — is also likely to be pulled forward by a year to next July, or perhaps this financial year, albeit that would “complicate the system somewhat”.

A significant increase in infrastructure investment is also possible, along with other reform items possible, potentially including a broadening of items covered by the GST, and an increase in the 10 per cent rate, to partly fund the household tax cuts, albeit perhaps not until 2021-22.

More transition payments to state governments to encourage a switch from inefficient stamp duty to land tax are also on the cards, according to Tharenou.

All up he’s now factoring in at least another $30bn of fiscal stimulus to be announced in the near term, leading him to upgrade his June quarter GDP forecast to minus 5.5 per cent, while his September and December quarter growth forecasts are unchanged at 1.3 and 0.2 per cent, “both have downside risk from COVID seeing ongoing restrictions”.

After exceptionally strong household cashflow in the June quarter, lessening stimulus is expected to see households run down their savings, particularly if lockdowns persist or worsen.