Macro (Re)view (24/7) | Fiscal takes up the running

The main theme over the past week was fiscal authorities the world over moving towards providing additional support to their pandemic-hit economies. The onset of the crisis resulted in quick and aggressive policy easing from central banks, but the sustainability of the recovery coming out of shutdowns will require progress firstly on the health front and secondly through ongoing fiscal support. In Australia, extensions to key income support measures were announced, while offshore European leaders agreed to terms for the €750bn recovery fund and in the US negotiations continued towards the phase 4 stimulus package. 

Starting domestically, the Federal Treasury handed down its Economic and Fiscal Update (reviewed here) this week ahead of the budget to be delivered in early October. Treasury estimates that on budget night the deficit for 2019/20 will be $85.8bn (4.3% of GDP) before widening out to $184.5bn (9.7% of GDP) in 2020/21. In pre-pandemic times last December, small budget surpluses of $5.0bn and $6.1bn were anticipated in 2019/20 and 2020/21 respectively. The seismic shock caused by the pandemic has plunged the nation into recession for the first time since the early 1990s with significant repercussions for public finances. The deterioration in the budget position for 2019/20 comes from $58.4bn in policy support measures and a weak economy that dents the coffers by $32.4bn, while in 2020/21 policy measures ramp up to $118.4bn and the impact of the recession escalates to a $72.2bn hit to the budget.

These latest estimates incorporate the announcements from this week regarding the extension to the JobKeeper policy and enhanced JobSeeker payment, though further changes could be delivered before October and that would alter the budget projections. On these measures, a 6-month extension was announced to the JobKeeper (wage subsidy) policy to cover the December quarter of 2020 and then the March quarter of 2021, with firms needing to satisfy the existing revenue test each quarter to retain the support. For the December quarter, the flat payment of $1,500 per fortnight is lowered and then tiered to $1,200 for those working more than 20 hours per week and to $750 for workers that come in below that threshold, while in the March quarter a further reduction is penciled in at $1,000 and $650 respectively. This extension increases the size of the policy from around $70bn to $85.7bn over the two years from 2019/20 to 2020/21, though it is still significantly below Treasury's initial estimate of $130bn so there is potentially scope for further support beyond this. Meanwhile, the coronavirus supplement for JobSeeker recipients has been extended by a further three months through to the end of 2020, though the size of the enhancement lowers from $550 to $250 per fortnight from September 25 onwards, in effect lowering the maximum payment available from $1,116 to $816 per fortnight. The extension to the coronavirus supplement costs $3.8bn, with the overall package advancing to $16.8bn. The extensions to JobKeeper and the JobSeeker enhancement together with other initiatives recently announced adds in the order of $22bn in direct support and will help to reduce the gradient of the 'fiscal cliff' that would have otherwise loomed at the end of September. This has lifted total direct support from the Commonwealth to $164.1bn, or to around 8.2% of annual GDP, with $111.8bn of this coming through in the current financial year (see chart of the week, below). 

Chart of the week

Public net debt is now forecast to hit $488.2bn (24.6% of GDP) in 2019/20 and then rise to $677.1bn (35.7% of GDP) in 2020/21. This is, however, comparatively low by global standards and as RBA Governor Philip Lowe highlighted in a speech this week, it is entirely appropriate for the government to be using its balance sheet to smooth out the substantial hit to incomes the pandemic has brought on and to limit the potential for it to inflict longer-term scarring on the economy by permanently reducing its productive capacity. Furthermore, Governor Lowe noted that the government is able to fund deficit spending on very favourable terms with bond yields down at historically low levels, while there continues to be very strong demand for those securities in global markets. In Governor Lowe's speech and in the July meeting minutes, it was highlighted that the Board had reviewed its monetary policy stance and considered alternative options. Overall, the Board concluded that its current stance was appropriate, though it would be prepared to make adjustments if the circumstances were to warrant that course of action. This would most likely be a further reduction in the cash rate (to as low as 0.1%) or more bond purchases, but negative interest rates, foreign exchange intervention and direct monetary financing are not seen as options that it needs to keep on the table. In a light week for data releases, retail sales advanced by 2.4% on a preliminary basis in June driven by the reopening of cafes, restaurants and discretionary stores, while exports were estimated to have risen by 8% in June on strong Chinese demand for iron ore as imports posted a smaller increase of 6%.  

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Developments offshore this week highlighted the spread that is starting to widen in the economic recovery in Europe compared to the US. This was not reflected in the price action in equity markets but it was in foreign exchange with the US dollar index down in the order of 1.6% over the week, which lifted the Euro, Sterling, Yen and Australian dollar (see table, below). A less constructive relative view on the US saw real yields drifting further negative to their weakest levels since 2012 with markets speculating that more support will be required from the Federal Reserve. 

On policy this week, European leaders reached agreement on the terms of the €750bn recovery fund after almost five days of negotiations. This will allow the European Commission to use its triple-A rating to issue common bonds and provide a mechanism for fiscal transfer to its member nations that have been hit hardest by the pandemic but are constrained by the state of their public finances. The terms were not as favourable as they might have been with €390bn to be disbursed in grants and €360bn in low-interest loans, whereas the initial proposal put forward by Germany and France was for as much as €500bn in grants and €250bn in loans. In the end, the north, led by the Netherlands, was successful in its push for a greater share of the funds to be disbursed as loans and greater conditionality on how it is to be used, but it was still clear progress in moving towards a fiscal union and it will encourage nations in the bloc to implement structural changes identified in the European Commission's Country Specific Recommendations to lift the growth potential and resilience of those economies.

Over in the US, Congress is struggling to agree to the details of its next stimulus package at a time when the enhancement of $600 per week to unemployment insurance is due to expire at the end of the month. The Democrats want to see this extended through to the end of the year, while the Republicans are divided with some wanting it to be extended but at lower levels, while others are reluctant to moves for more support to be injected. Notwithstanding this, markets still expect some extension of the enhancement as well as another round of stimulus cheques of $1,200 for individuals, though it may take some time to reach that agreement. 

Together with divergence on progress towards fiscal support is vast differences in health outcomes as virus cases have surged in the US since June as it spread down to the south and to the west while Europe has been able to avoid further outbreaks. The relative differences in the reopenings of the two regions can be seen in July's flash PMI readings that were released this week. On a composite basis, activity in the euro area advanced from 48.5 to 54.8 (readings > 50 indicate expansion) signalling that growth was starting to return early in Q3 with output and demand picking up coming out of the shutdown, whereas in the US conditions were only able to stabilise in rising from 47.9 to 50.0 held back by reversals of reopenings. In particular, the impact of the pandemic has mainly been a services story and here the contrast is sharp with Europe now starting to expand (55.1 from 48.3) just as the sector in the US is still in contraction (49.6 from 47.9).