MIKE TOWNSEND: Every time it seems like the news might slow down, like maybe we could all just catch our collective breath for a moment, there’s more.
Just eight days after the death of legendary Supreme Court Justice Ruth Bader Ginsburg, the president nominated someone who could change the court’s balance for a generation.
In the United States, we crossed the grim milestone of 200,000 deaths due to COVID-19, and worldwide have now passed the mind-boggling total of 1 million lives lost—with no end in sight.
And last week the president of the United States did not commit to a peaceful transition of power if his opponent wins an election that is now just 32 days away.
Feeling overwhelmed yet?
Welcome to WashingtonWise Investor, an original podcast from Charles Schwab. I’m your host, Mike Townsend, and on this show, our goal is to cut through the noise and the nonsense of the nation’s capital and help investors figure out what’s really worth paying attention to.
In just a few minutes, I sit down with Kathy Jones, Schwab’s resident Fed expert, to talk about Fed Chair Jerome Powell’s three-day tour of Capitol Hill last week, the Fed’s new policy around inflation and interest rates, and what it all means for investors.
But first, here’s a look at some of the other relevant issues making news this week.
Over the weekend, President Trump nominated Amy Coney Barrett to the Supreme Court to replace the late Justice Ruth Bader Ginsburg. The move infuriated Democrats, who believe that the winner of the November 3 presidential election should choose the next justice. But Democrats have no ability to block the nomination, which will proceed on an accelerated time schedule.
The Senate Judiciary Committee outlined a plan to hold confirmation hearings during the week of October 12, and the committee would potentially vote on Barrett’s nomination on October 22.
That would set up a possible confirmation vote by the full Senate during the week of October 26—just a week before the election. Now that could be delayed, meaning the vote would take place just after the election rather than just before.
But the outcome seems preordained at this point. Republicans need only a simple majority of 51 votes to confirm Barrett to the Court. With a 53-47 majority in the Senate, Republicans could lose as many as three members of their caucus and still have enough votes for confirmation, as Vice President Mike Pence would break a 50-50 tie. Right now, only Maine Senator Susan Collins and Alaska Senator Lisa Murkowski have publicly expressed concerns about the process, the timing, or the nominee, but even if both vote no on Barrett’s confirmation, Republicans still have wiggle room. Barring something unexpected, Barrett’s elevation to the highest court in the land seems assured.
Democrats cannot block the vote. Republicans changed Senate rules in 2017 to prohibit filibusters of Supreme Court nominees. Democrats can slow down the process, but that would only delay the inevitable. It’s unclear at this time how many of those delaying tactics they will use, but they could potentially force a delay in the final confirmation vote until after the election.
Republicans would like to see Barrett on the Court before or shortly after the election because the Court is scheduled to hear a case on the Affordable Care Act on November 10, and because the Court could be involved in decisions regarding voting if there are legal challenges and disputes over the election.
Does the market care about the Supreme Court confirmation battle? I don’t think it cares that much. First, the outcome seems pretty clear at this point, so there’s not much uncertainty. And while Barrett’s confirmation would lock in a conservative 6-3 majority on the Court that some analysts believe could eventually benefit business interests, that impact is probably years down the road and not likely to have much immediate effect on the business environment.
To me, the larger issue is that the Senate seems completely broken. The two parties no longer even pretend to work together, and they keep changing the rules to ensure that they don’t have to. In 2013, Democrats changed the chamber’s rules to prohibit filibusters of certain judicial nominees. In 2016, Republicans refused to even hold hearings for President Obama’s nominee for a vacancy on the Supreme Court, arguing that nine months was too close to an election. In 2017, Republicans expanded the filibuster ban to include Supreme Court and Cabinet nominations.
Now, in 2020, we have Republicans racing to seat a Supreme Court nominee closer to an election than any in history. And with Democrats favored to take the majority in the chamber in 2021, the possibility of eliminating the filibuster entirely looms large. The Senate has become the epicenter for the bitter divisions that are pulling at the very fabric of our democracy.
There was a bright spot on Capitol Hill last week, however, as Congress did manage to find a rare bit of common ground on one important issue, agreeing to a deal to fund federal government operations until December 11. That was necessary because the government’s fiscal year ended on September 30. Congress is required to approve the 12 appropriations bills that fund every federal agency and federal program for Fiscal Year 2021 by September 30 in order to avoid a government shutdown when the new fiscal year begins on October 1.
This year, due to the pandemic, election-year politics, and other factors, Congress failed to pass even a single one of the 12 appropriations bills. That meant a stopgap measure was needed, and House Speaker Nancy Pelosi and Treasury Secretary Steven Mnuchin negotiated a compromise that keeps the government funded through that December 11 date. The House passed the bill last week; the Senate agreed earlier this week.
Lawmakers will have to come back to Washington after the election for a so-called “lame duck” session, and one of the items near the top of the list will be figuring out how to fund the government past that new December 11 deadline. And that could be tricky, particularly if the election is still in dispute at that time.
The deal to keep the government open and operating was technically the last “must-do” item on Congress’s list before the election. And that means there’s not much hope of another coronavirus aid and economic stimulus bill before November.
It’s hard to believe now, but the last aid bill was signed into law at the end of April. At the time, it seemed all but certain that lawmakers would approve more aid—it was just a question of when. The key date was July 31, when the enhanced unemployment benefits and other temporary programs that were part of the $2.2 trillion CARES Act were set to expire. But that date came and went without any further action by Congress, and weeks just kept ticking by without another deal.
This week, House Democrats, who approved a stimulus bill known as the HEROES Act back in mid-May, made another last-minute attempt. They put forward a slimmer bill of about $2.4 trillion as an alternative. But that bill never had a chance with Republicans, who have barely moved from their offer of $1 trillion in aid back in July. The key issues, from the size of the total package to the amount of aid for state and local governments to the amount of enhanced unemployment benefits—among others—remain unresolved.
House Speaker Pelosi and Treasury Secretary Mnuchin are reportedly still talking and plan to do so well into October, but it seems highly unlikely that some sort of compromise will come together before the election.
One voice that has been crystal clear about the need for more economic stimulus has been Fed Chair Jerome Powell. On my Deeper Dive this week, I want to explore what Powell has been saying and how the Fed generally has been handling the crisis. To do that, I’m really pleased to be joined by my terrific colleague Kathy Jones. Kathy is the chief fixed income strategist at Charles Schwab and one of those people who has a real gift for making the sometimes-mysterious words and actions of the Federal Reserve understandable to ordinary investors.
Kathy, thanks so much for joining me.
KATHY JONES: Great to be here, Mike.
MIKE: As I said, last week was a big one for Fed Chair Jerome Powell—with three days on Capitol Hill testifying before two committees in the House and one in the Senate. Did anything stand out to you about Powell’s comments to lawmakers?
KATHY: Two things stood out to me, Mike. First, he doesn’t want to get involved in partisan politics. When asked about various policies that don’t have anything to do with the Fed, he pushed back a bit more forcefully than I have seen him do in the past. Perhaps that reflects a level of frustration that many of us feel about what’s going on in Washington, D.C., but he clearly doesn’t want to be put in a position of providing sound bites for members of Congress.
And secondly, Powell really, really would like to see Congress step up with more fiscal relief. Time and again, when given the opportunity, he emphasized the need for fiscal policy to do more. I think he said the words “fiscal policy” over 30 times by my count. He emphasized that fiscal policy is far more powerful in getting funds directly to households during an economic downturn than anything the Fed can do. He used a phrase that he’s used several times in the past: “The Fed can lend, but it can’t spend.” In other words, the Fed can make it easy to borrow, but it can’t increase unemployment compensation or provide direct subsidies to small businesses. My takeaway is that the Fed knows that it has pushed the limits of what monetary policy can do, and in lieu of a vaccine or cure for the COVID-19 virus, the economy is likely to struggle—with unemployment staying high. So Powell was very direct in asking Congress to do more spending.
MIKE: Well unfortunately, Kathy, it seemed like that message fell mostly on deaf ears; because at this point, it looks like it will be after the election or even early 2021 before Congress passes another aid bill. Is that delay significant for fixed income investors?
KATHY: Lack of action by Congress likely means bond yields stay low. That means prices for bonds that are considered less risky, like Treasuries or highly rated municipal bonds, would stay high. But bonds that are more exposed to credit risk may underperform. So if you are holding corporate bonds—especially high-yield bonds, for example—you may see a decline in price if it appears that the economy is falling back into a double-dip recession. Although the Fed is providing a backstop for the corporate bond market, it’s only buying ETFs and a small handful of below-investment-grade corporate bonds. Consequently, if the economy worsens, then it’s likely that there will be more downgrades and defaults in the riskiest parts of the market—like high-yield bonds.
On the other hand, it means that the Treasuries you hold could continue to rally on the prospect of continued low inflation and the Fed keeping short-term rates near zero for a long time.
MIKE: Kathy, a common question that you and I get at our virtual events these days is whether the Fed has anything left in its arsenal should the economy worsen. Are Powell’s calls for more fiscal stimulus evidence that the Fed is out of tools? We talked about this on the podcast in the spring, but has your view on this changed at all?
KATHY: In the big picture, the Fed is never out of tools. It can still exert influence over the markets by expanding its balance sheet through more asset purchases and engaging in yield curve control. That’s where it targets certain maturities to hold long-term rates down. It also has regulatory powers over the banks. During the spring when the crisis hit, the Fed eased those regulations to allow money to flow more easily into the economy. There’s still some wiggle room there. And it can make money cheap and widely available to businesses and households, which is an incentive to invest and spend. However, there will be diminishing returns from these policies because the Fed doesn’t have a lot of wiggle room here because yields are already very low, and there is ample liquidity.
More importantly, the message from Powell is that fiscal policy is much more effective in situations like this—and that’s the responsibility of Congress. Fiscal policy can actually put money directly into the pockets of those most likely to spend it. Fiscal policy can mean getting a deposit in your bank account—money that can flow into the economy right away and won’t increase an individual’s debt burden.
MIKE: Well, as we wait for Congress to pass more aid, this winter brings with it several more serious concerns, such as will we be hit by a second wave of COVID? Will businesses that have limped along survive another spike in unemployment or flagging demand? And I’m thinking of one’s favorite restaurant that can’t rely on outdoor dining once winter hits. How concerned are you about these risks? How do you think the Fed will respond?
KATHY: I am very concerned. I don’t think a double-dip recession is the most likely outcome, but it is a risk. As you mentioned, another wave of COVID cases could dampen consumer spending, and it would really hit the service sector at a time when it’s already very weak. Small businesses, which employ the bulk of the workforce, are the most vulnerable—restaurants, bars, retail shops. On top of that, the whole travel/leisure group—airlines, cruise lines, hotels, etc.—are weak and shedding workers. The other big concern is state and local governments. Tax revenues are falling. Expenses are rising. State and local governments will be laying off workers and cutting services—adding to the economy’s weakness.
The Fed would likely respond with more asset purchases to provide a backstop for the riskier segments of the market. That’s not a cure-all, but it can make funding easier and more widely available. It could also consider expanding some of its lending programs or easing the terms of those programs. These moves would likely mean that bond prices in riskier segments of the market—like high-yield or emerging-market bonds—would rise.
MIKE: Kathy, let’s shift gears a bit. In August, the Fed announced a strategy shift that some headlines called “The biggest inflation policy change in decades.” Now, you’re fantastic at explaining Fed policy in plain English, so can you tell us what’s going on here? Is this the landmark event that everyone is saying it is?
KATHY: It really is pretty simple. The Fed is going to wait for inflation to show up before it raises interest rates. That’s a big change. For more than 70 years, the Fed has tried to get ahead of inflation by pre-emptively hiking short-term rates whenever its models indicated inflation was going to rise. The models were based on the unemployment rate. If it dropped too low, then inflation would pick up. But the models stopped working, and now deflation, or disinflation, is more of a worry than inflation. So now, the Fed is fine with inflation moving up for a while, if it means the unemployment rate drops. It may not seem like a big deal—but it really is.
MIKE: So if this is a big deal—practically speaking, what does the Fed’s new strategy mean for people who, for example, are relying on higher interest rates for retirement income?
KATHY: It’s going to continue to be difficult to find attractive bond yields without taking a fair amount of risk. Ten-year Treasury yields are stuck at about 0.70%, and since that’s the benchmark against which other bonds trade, it sets a very low bar. In other words, a corporate bond of similar maturity would be priced at some yield spread over 10-year Treasuries. Now, historically, it might have been around 1.0% to 2.0% above U.S. Treasuries. In this market, it gives you a yield of about 1.7% or maybe 2.2%. That’s better than the current yield on Treasuries at 0.7%, but not especially attractive.
To get yields in the 4% to 5% region—which is what a lot of investors would need to generate the kind of paycheck in retirement that would maintain their standard of living—you have to take considerable risk. That would put you into high-yield or junk bonds or perhaps emerging-market bonds. Those types of bonds tend to have much higher risks of default or downgrade than investment grade or municipal bonds. It doesn’t mean you’re sure to lose money in bonds. In fact, year to date, bonds have done very well. However, it does mean investors are going to have to be very thoughtful about what types of bonds they invest in. One strategy many investors will likely need to consider is using the whole portfolio to generate the cash flow you need for retirement—that would include using capital gains and other sources of income like dividends.
MIKE: Kathy, I want to go back to something you said just a minute ago, where you said that deflation right now is in some ways more of a worry than inflation. So do you see a point where inflation might be a worry again?
KATHY: Meaningful inflation only really shows up when there’s more demand for goods and services than supply. We used to describe it as “too much money chasing too few goods.” Right now, demand has dropped pretty sharply as a result of the pandemic—we’ve seen widespread layoffs and business closures, especially service-oriented businesses. It’s hard to generate inflation when there’s weak demand and a big rise in unemployment, since that produces an excess supply of labor.
It’s going to take a lot lower unemployment, especially among lower-income workers, to get inflation to rise. Higher-income workers tend to save more of what they take in, while lower-income workers tend to spend most of what they make. In this recession, lower-wage workers have been hit the hardest. It’s going to take a while—I would guess at least three to four years.
But the reality is that many people feel like inflation is higher than what the government statistics indicate. They usually cite the cost of higher education and health care, which have been rising at a faster rate than the overall inflation rate for many years. What the Fed looks at is a basket of goods and services that is supposed to represent the average household. Their favored measure—the core personal consumption expenditures—is more heavily weighted to services and consumer preferences. The result is that it tends to be on the low side of the range of inflation measures. So it’s a bit of a conundrum for the Fed. Monetary policy is a pretty blunt tool—it can’t easily differentiate with regard to sectors of the economy or price levels of different goods and services.
MIKE: Well Kathy, one of the most common questions that clients are asking me these days is “But Mike, what about all of this debt?” With the government spending nearly $3 trillion already this year on pandemic-related relief and stimulus programs, the federal deficit has skyrocketed, and the national debt continues its steady climb. Is all of this debt going to catch up to us—maybe increase inflation, weaken the dollar?
KATHY: I hear the same thing all the time, Mike, and it is a concern. Right now, the level of debt in the U.S. is approaching an all-time high. However, since interest rates are low, the cost of servicing the debt really hasn’t changed all that much over the past decade. So for now, it’s sustainable. Longer term, financing it could be a problem for the markets. Foreign investors hold about half the U.S. debt, so we need to attract capital from abroad. That’s been pretty easy since we have the world’s reserve currency, and over 80% of global transactions take place in U.S. dollars. That creates underlying demand that supports the dollar, and those dollars tend to get invested in Treasury securities. Longer term, if foreign investors lose confidence in our stewardship of the debt, yields may need to rise and/or the dollar would weaken in order to attract that foreign capital.
As for inflation and the debt, it’s more likely that high debt levels will be negative for growth than inflation. When a bigger chunk of the budget goes to debt service, it tends to limit investment and growth.
MIKE: Katy, something I’ve been wanting to ask you for a while: Back in March and April, when the crisis started, the Fed really put things together very quickly—they’d never really faced anything like this before—so it felt like they threw a lot of ideas against the wall. Some stuck. Some didn’t. So what’s not working, and what’s being done to improve the Fed programs that have stalled a bit?
KATHY: From the Fed’s point of view, the lack of usage of the programs is not a failure. Various Fed officials have said the programs are just meant to backstop the markets, and since the markets are functioning well, that’s a sign of success. However, I do think there are some pretty glaring areas where the programs haven’t reached their targets. For example, the Main Street Lending Program is getting less usage than you would think, and it’s probably because the minimum loan is too high ($250,000), and the banks are being very cautious in their lending. There’s a gap between the small-business facility, called the PPP, and the Main Street program that leaves out a lot of businesses. And I don’t see much action at the Fed to do more on that right now.
The other area is the Municipal Lending Facility that has been used by only a handful of borrowers because the rates are very high. There’s still a lot of state and local governments that need a source of funding but are reluctant to go to the MLF.
Going back to our earlier conversation—the Fed would really, really like to see Congress step up and provide more fiscal relief. As Powell has said, the Fed can “lend, but not spend.” Struggling businesses and municipalities could use grants or direct aid more than more debt.
MIKE: Kathy, at this point we’re a little more than 30 days out from election day. So I’m wondering if the fixed income market cares about the election. Why or why not?
KATHY: Yes—to the extent that it will influence fiscal policy, the fixed income markets will care. Also, if there’s a lot of delay in getting the results after Election Day, then there’s a potential for a flight to safety into Treasuries. However, I wouldn’t make too much of the presidential race in terms of policy impact, but rather the Congressional races. Congress holds the purse strings. If there is expansive fiscal policy coming out of the election, it could push up interest rates a bit. But it might actually be good for the municipal bond market if Congress provides more direct funding to struggling state and local governments. If there is a standoff and limited spending, then the bond market will likely reflect that with Treasury yields moving down and perhaps some negative impact on corporate bonds. But overall, the Fed is much more important to the bond market than who’s in the White House.
MIKE: How about the U.S. dollar—do you see it being impacted by the election?
KATHY: The dollar is more likely to be sensitive to what happens in the election. The foreign exchange market is quick to react to political events. A stalemate or uncertainty over the election results could send the dollar lower. Longer term, it depends on the mix of fiscal and monetary policy. The dollar’s been in a downtrend over the last few months, and we would expect that trend to continue, but if there is big spending coming out of Congress that lifts the economy’s prospects, then the dollar would rally. If it looks like continued stalemate and sluggish growth, then the dollar will likely weaken. For investors, a stronger dollar tends to be positive for bonds because it lowers the cost of imports, while a weaker dollar tends to add a bit to inflation.
MIKE: Kathy, you’ve given us a lot to think about in this conversation. Let me finish up with this. What should we be focused on today as fixed income investors? What are you telling investors who feel like they should be doing something, anything in response to all the things that are going on in the world?
KATHY: I would advise thinking longer term rather than focusing on the next few months. It’s a good time to review your portfolio. If you’re investing for the next five to 10 years and you have a solid financial plan, you may not need to do anything. If you’re outside of your normal allocations, then you may want to rebalance. We believe that diversification is going to be more important than ever in the next few years. There is such a wide range of potential outcomes for the economy and for policy that we think it makes sense to have exposure to many asset classes as a way to mitigate some of the risks in the individual investments. For fixed income investors, that might mean having both short- and long-term bonds, maybe some inflation-linked bonds like TIPS, and a mix of corporate and municipal bonds.
MIKE: Kathy, as always, you’ve given us a lot of great advice today. Thanks so much for joining me.
KATHY: Thanks for having me, Mike.
MIKE: That’s Kathy Jones, Schwab’s chief fixed income strategist. I highly recommend that you follow her Twitter account, @KathyJones.
It’s time for my Election 2020 update. This week saw the two presidential candidates meet for the first of three debates. The 90-minute debate degenerated quickly into a barrage of interruptions and personal insults that rarely resulted in substantive policy discussions. Moderator Chris Wallace struggled to control the debate, and there were so many times when the candidates were talking over each other, or talking over the moderator’s attempts to ask a question, that it was often hard to understand what anyone on the stage was talking about. Pundits ripped the debate as “ugly,” a “travesty,” and “an insult to the public,” with several television commentators saying afterwards that it was “the worst presidential debate in history.”
Whether that’s true or not, the question really is whether the debate matters. Polling has consistently shown that the number of undecided voters is unusually small. One recent poll found that 71 percent of voters said that the debates mattered little or not at all to how they plan to vote.
Markets appeared to react mostly with indifference, as there was little indication that the chaotic debate had any measurable impact on the race.
As I’ve said before, the presidential race has been steady for months, with Joe Biden holding a lead of between six and eight percentage points in national polls, on average, since late May. Despite everything that has happened since then, the lead has been essentially unchanged.
For the Trump campaign, they need a dramatic re-setting of the race—and they did not seem to get that on Tuesday night. The president will get two more chances in upcoming debates on October 15 and October 22. But it’s possible that tens of millions of voters will have voted by then, either in person or by mail, so those final two debate opportunities may come too late to affect the outcome.
Finally, I’m continuing to watch the market’s reaction to the upcoming election, and there are clear signs that the market is getting increasingly concerned about an extended period of uncertainty after Election Day.
I’ve been saying for months that there is little chance we will know the winner of the presidential election on Election Night and virtually no chance at all that we will know who won the critically important battle for control of the Senate. That’s because counting tens of millions of mail-in ballots just takes a lot longer than counting ballots that are inserted directly into a voting machine on Election Day.
Two important things to know. First, there are a number of states where mail-in ballots need only be postmarked by Election Day, meaning that they can come in two or three days later, even a week later in some states, and still be counted.
Second is that there are big differences across the country in when election officials can begin processing and counting mail-in ballots. In most states, mail-in ballots can be opened and processed prior to Election Day—it’s just that no actual ballot counts can be reported until after the polls close in those states. So those states will have a bit of a head start that could mean they have results relatively quickly.
But there are 11 states where election officials cannot even open the envelopes containing mail-in ballots and begin processing them until Election Day. Among the states that have that rule are Michigan, Pennsylvania, and Wisconsin, three key battleground states that were central to the 2016 outcome and are expected to be very important again in 2020. It could be several days before we know the outcome in those states.
Now there’s growing evidence that investors are worried about this potential uncertainty. The Wall Street Journal reported earlier this week that big bets are being made on post-election volatility, with investors using strategies with futures, currencies, and other investments to either hedge against or take advantage of volatility. At Schwab, we continue to think that investors should not make dramatic alterations to their financial plan—and you should talk with your financial advisor before making any big investing decisions related to the election.
That’s all for this week’s episode of WashingtonWise Investor. We’ll be back with a new episode in two weeks.
Please take a moment now to subscribe so you don’t miss our next episode, as we continue to follow the election and other stories that may impact the markets and your portfolio. And if you like what you’ve heard, leave us a rating or a review on Apple Podcasts or your favorite listening app—those ratings and reviews really do matter.
For important disclosures, see the show notes or schwab.com/washingtonwise, where you can also find a transcript.
I’m Mike Townsend, and this has been WashingtonWise Investor. Wherever you are, stay safe, stay healthy, and keep investing wisely.