A third Fed policy
In his speech to the London School of Economics, Dallas Fed President Richard Fisher outlined how “fiscal drag” is holding back GDP growth. The Dallas Fed estimates that fiscal drag cost the economy 1% in GDP growth last year. There was a “disconnect” between fiscal and monetary policies, with the Fed accelerating economic stimulus and fiscal policy applying the brakes.
Richard Fisher on fiscal drag
Although the Fed has made cheap money readily available, firms still shy away from job creating capex due to business uncertainty. While uncertainty may be good for business from a Schumpeterian view, “Total business uncertainty is an inhibitor.” While businesses have some clarity, they have “no idea what their tax rates are going to be, no idea what redistribution of federal spending is going to be,” which is a big factor in their economic calculation. The budget has contributed to the uncertainty, first with the standoff, and second with its short-term timeframe.
“Here’s the bottom line,” said Fisher. “Monetary policy is uber necessary but it’s insufficient and we need a third arrow as is expressed in Abenomics in the United States and we don’t have it. And as long as we don’t have it, we will inhibit the effort of monetary policy… We know that, we take it in to account in our discussions how much inefficiency is built into the system by virtue of the fiscal policy, but we also realize that there is a limit to what we can do… Our massive monetary accommodation will not have the effect we would like it to have, unless we have fiscal cooperation.”
However, the Fed anticipates a lift in GDP growth, “as there is no longer a standoff on the budget, and willingness from Congress to cooperate with the Executive on that front.”
What does an increase or decrease in GDP growth mean for investors?
An increase in GDP growth would benefit the economy. However, this would also mean increasing rates as the Fed plans its normalization strategy. For a detailed analysis on what normalization means, read on to Part 6 of this series.
Rising interest rates would mean falling bond prices. In a rising rates environment, fixed income investors can profit by investing in floating rate ETFs like the VanEck Vectors Investment Grade Floating Rate ETF (FLTR). The interest rates on floating-rate notes aren’t fixed but are reset at periodic dates based on a market reference rate.
Investors can also benefit by investing in inverse bond ETFs like the ProShares Short 20+ Year Treasury (TBF). Inverse bond ETFs provide returns inverse to or opposite to the underlying benchmark index, which would benefit these ETFs as the Fed begins normalization and monetary tightening.
An increase in GDP is also likely to benefit retail sector ETFs like the VanEck Vectors Retail ETF (RTH), which tracks the VanEck Vectors US Listed Retail 25 Index. The index is designed to track the overall performance of the 25 largest publicly listed retailers in the U.S. The top holdings in the ETF include Amazon.com (AMZN) at 8.1% and Wal-Mart Stores Inc. (WMT) at 8.04%.
To find out what impact quantitative easing has had on income distribution, continue to Part 9 of this series.