Last week, as US President Barack Obama delivered a speech outlining his vision for America’s fiscal future, Peter Fisher was travelling through Asia to meet major institutional investors.
The budget deficit has become the number-one political issue in the US, invigorated by Paul Ryan, a Republican congressman from Wisconsin who recently presented the first serious attempt to write a long-term fiscal plan that cuts spending.
Obama and the Democrats’ response is more about fixing the budget rather than bowing to the Grand Old Party’s ideological drive to shrink the role of government.
For Asian investors with big exposures to US financial assets, the outlook for the US, with its massive unfunded liabilities, is important, and there is widespread concern about whether America’s political system can really address its long-term debts.
Fisher is head of BlackRock’s $1 trillion-plus global fixed-income business, and formerly its Asia chairman. He served as executive vice-president at the Federal Reserve Bank of New York and as an undersecretary of the US Treasury.
His message is that, regardless of whatever laws emerge from the political divide, both sides are talking about fiscal rectitude. He notes that President Obama may have spent most of his speech attacking the Ryan Plan, but in doing so he cloaked the acknowledgement that he is also going to cut spending on Medicare, one of America’s big-three entitlement programmes.
So the pendulum in American politics has begun to swing from 10 years of major fiscal stimulus (Bush tax cuts, Medicare drug benefits, military build-ups, post-crisis fiscal stimulus) to a new mood in which the two parties are now competing on the grounds of fiscal discipline.
This has immediate implications for investors. The political shift means there will be less government support in the equation of GDP. Individual states have already begun paring back spending, and the federal government will follow.
The Federal Reserve will surely account for this as it forecasts US GDP for the next several years. The short-term negative impact this will have on US GDP will be one factor against the Fed tightening monetary policy.
There are other reasons why Fisher believes the Fed will not actively seek an ‘exit strategy’ from the huge expansion of its balance sheet pursued since March 2008. The Fed has made clear it will fulfil its second round of quantitative easing by completing its goal of $600 billion worth of asset purchases by June.
But will the Fed then actively tighten policy? Fisher doubts it. He says once ‘QE2’ is over, the Fed will have to tell the market if it plans to reinvest the proceeds of its fattened balance sheet, or let the assets mature and put the proceeds into run-off straight away.
Reinvesting the proceeds effectively means the Fed will retain a neutral policy, which is what Fisher expects. Putting the proceeds into run-off would represent a passive form of policy tightening.
Assuming the Fed does maintain a neutral stance, the next question will be if and when it starts to actively tighten, by raising interest rates and/or shrinking its balance sheet by allowing some or all of its maturing assets to run off.
Despite the rise in commodity prices and the threat of inflation, Fisher believes the Fed will not be in any hurry to tighten its stance. It will have to be concerned about the fall in government spending as a component of GDP; about the fear of higher commodity prices acting as a brake on consumption; and about the stagnant housing market.
Meanwhile, business fixed investment is modest (most companies have huge cash piles on their balance sheets) and exports, although positive, may not surge if growth in Asia and Europe is slowing.
Fisher doesn’t respond directly to questions about whether rival Pimco is right in its belief that Treasuries offer negative value. He says parts of the spread market are still attractive, including asset-backed securities, high-yield and emerging-market debt. But he warns that the easy gains have been made and investors should look at security selection rather than make bold sector bets.
He does not expect US interest rates to suffer a major change; he suspects rates will remain range-bound.
He notes that many of BlackRock’s competitors have been predicting for two years that US interest rates are going to rise right away. Fisher says BlackRock approaches rates as a tactical trading opportunity.
This is partly because the Fed is not going to jack up rates right away. But it’s also technical. Investors both in the US and worldwide have an enduring demand for long-duration assets. The financial crisis means private issuers of credit are still relatively inactive.
There is very little supply of new long-term credit, which gives the US government little competition. Money has to go somewhere. For now, corporate balance sheets are cash-rich, so there is no reason for companies to tap bond markets. US households, corporations and foreign central banks are all net savers, which means the US government can afford to borrow.
Some investors are concerned about the US, and the world, returning to the stagflation of the 1970s and the very high interest rates of the Paul Volcker period at the Fed in the 1980s. It is this fear that has led investors to assume the Fed must jack up interest rates more quickly than the markets can handle.
Fisher is not convinced. He says over the course of a century or more, the high rates of the '70s and '80s may be an aberration. Even if the Fed raises its federal funds rate, reflecting somewhat improved GDP growth in the US, the yield curve is so steep that it might not have much impact on the longer end. Given aging societies, slow credit growth and the need among pension funds and other investors for long-duration assets, the US government may have plenty of manoeuvring room.
One final question to Fisher is about how his clients in Asia – the big central banks and state-linked funds – view QE2 and American profligacy. The media has covered complaints in Asia, Brazil and elsewhere that the Fed was stoking inflation in local markets.
Fisher puts it this way. Global monetary authorities would be outraged if the Federal Reserve demanded they all adopt US monetary policy. But today, it sounds like the rest of the world is demanding exactly this; that the US sets their monetary policy. The Fed’s response is that other countries need to learn to set their own policies.
Fisher does not mention the words ‘China’, ‘yuan’, ‘exchange rate’ or ‘convertibility’. But the European Central Bank and the Bank of England have a long history of independent monetary policy. So this discussion must allude to Asian central banks.
Many monetary authorities are relatively new. Perhaps they're not used to setting their own monetary policy?
Fisher only says that the US will set monetary policy in light of its own economic conditions, and not conditions in other economies. As the US share of global GDP falls relative to the rise of other big economic players, it is only natural that other countries need to develop their own monetary policy.