US: Tale of two big fiscal expansions – Deutsche Bank

Alan Ruskin, Macro Strategist at Deutsche Bank, suggests that a comparison of the Reagan and Bush fiscal expansions provide a sobering tale for those that think all fiscal stimuli are born equal.

Key Quotes

“It is helpful when a fiscal stimulus takes place in the early stages of recovery and has an asset cycle tailwind like the Reagan 1983 package, compared to the temporary 2001/3Bush tax cuts that followed the longest recovery in history and an equity bubble already in a state of collapse.Though far better than the circumstances facing Bush, the current mature growth and asset cycle offer a cautionary note about the efficacy of fiscal policy.”

“What does this all mean for the USD?

Nonetheless there are at least six important reasons why a fiscal stimulus in current circumstances is much more helpful for the USD than the underwhelming FX response of the Bush years, even if the set-up is not nearly as conducive for the currency as the early Reagan years.

i) the real broad TWI is ~10% below the levels when the 1st round of Bush tax cuts hit, suggestive of more USD upside in this cycle.

ii) the cyclically adjusted US C/A deficit is not signaling FX overvaluation, and our last FEER based valuation metric, dominated by the US external accounts still had the USD cheap. This is partly because of a much improved energy balance.In the Bush tax cut years, the C/A deficit was already over 4% of GDP, and above 5% of GDP in 2004.

iii) the asset cycle is working modestly with and not against the grain of the fiscal stimulus.

iv) there is very little spare capacity, so a small acceleration in growth will encourage a quick reappraisal of potential inflation pressures from the Fed.

v) the US will likely enact the largest fiscal stimulus of any of the G10 countries, and unlike past Fed cycles, will be the only G10 Central Bank tightening in 2017.

vi) It takes so little to be a high yielding G10 currency in a world of unusually low nominal and real rates.

There are of course numerous uncertainties on the scale and the breakdown of a Trump fiscal stimulus, not to mention FX and trade policies.What should not be in doubt is that the backdrop for a fiscal stimulus is significantly friendlier for the USD than the early G.W Bush years,even if not nearly as favorable as in Reagan’s first term, when Volcker reestablished Fed credibility.”