Wednesday Briefs – 23 June 2021

THIS WEEK: The Fed Warns; Head of State Changes; Ranked-Choice Voting.

THE FED WARNS

Hints from the Federal Reserve that it may rein in the easy money sent markets spiraling last week. But as the reversal this Monday shows, the decline was an overreaction. The Fed is predicting that it may hike near term rates, but not before mid to late 2023, which is more than two years away. At the same time, the Fed indicated that it may consider reducing some of its bond purchases.

Overall, these announcements are positive because they signal confidence in the longevity of the recovery. When interest rates rise for reasons of healthy economic activity rather than inflation fears, the economy and equity markets tend to do well. But contrary to last quarter’s expectations, longer term Treasury rates have been falling rather than rising. The 10-year now yields 1.475%, down from a high of 1.75% in early April (and up from 0.9% on January 1st). These levels are incongruous with current GDP growth and are due in part to the Fed’s market interventions. This table from the US Department of the Treasury shows that real rates are negative across all durations. And this is assuming the official inflation rate which is seen as a too-low estimate by many.

Source: US Department of the Treasury

Seen from a historical perspective, today’s interest rates are too low on the entire yield curve. At its current level, the equity market is anticipating higher rates. At a PE just north of 20x 2021 and 2022 earnings, the S&P 500 cannot be said to be expensive today when adjusted for treasury rates (the Fed model). There were periods in the past when a 10-year rate below 6% (and a T bill below 3%) would easily justify a market PE of 25x of more. This means that stocks are already pricing some inflation and rate increases. With the post-pandemic rebound gaining strength, the rest of the year should be positive in particular for 2020 lagging sectors. Unless inflation turns out to be even higher than anticipated by the market.

HEAD OF STATE CHANGES

In the past two weeks, the prime minister of Israel was replaced and a new president of Iran was elected. Visual Capitalist has plotted (bad choice of words) the world leaders of fifteen countries from 1970 to the present. The newcomers are President Biden, Israel’s prime minister Naftali Bennett and Japan’s Yoshihide Suga. The tenure of American presidents is subject to the two-term limit but many other countries have no such restrictions.

Germany’s Angela Merkel has been in power since 2005, a sixteen year run that is rare in Western democracies. By contrast, France has had two one-term presidents since 2007, Nicolas Sarkozy and Francois Hollande. The incumbent Emmanuel Macron faces a challenging re-election campaign next year. Since 2007, Great Britain has had four leaders, Gordon Brown, David Cameron, Theresa May and Boris Johnson. Australia has had six, Japan seven, Italy (not shown) eight.

Other countries have longer standing leaders. Russia’s Putin has been president since 2000, except for 2008-12 when Dmitry Medvedev was president and Putin was prime minister. China’s Xi Jinping has been in power since 2012. Further afield, several of the longest serving leaders in the world are in sub-Saharan Africa. The leaders of Cameroon, Equatorial Guinea, DR Congo and Uganda have all been in place for thirty years or longer.

A leader’s longevity in office can be transformative to a country. Four years are not enough to effect significant change, especially in a country with deep institutions like the US. Eight years make it possible but not easy. Ronald Reagan’s eight years, followed by George H. W. Bush’s four years, determined the country’s course for several decades. In countries such as Russia, Iran or others where the leader has been in office for decades, the directions of the economy and society will bear his mark for a longer time. As indeed was the case in the US with the twenty consecutive years of Franklin Roosevelt and Harry Truman.

RANKED-CHOICE VOTING

Democracies are always experimenting in everything. Some call this an insurmountable advantage; others call it the seed of their eventual demise. Perhaps it is both, an insurmountable advantage until one experiment gone wrong leads to demise. That is the nature of risk, a feature of democracy that can be harrowing for those who favor a steadier existence.

A novel experiment is ranked-choice voting, with the largest case playing out now in New York City’s Democractic primaries for Mayor. Under the ranked-choice system, voters choose not one but five candidates and assign a rank to each. If no candidate gets a majority on the first round, the candidates with the fewest votes are dropped and their votes are assigned to the remaining field based on their voters’ choices. If necessary, several similar rounds take place until one candidate secures a majority.

After the first round, Brooklyn borough president Eric Adams is the leader with 31.6%, followed by Maya Wiley 22.3% and Kathryn Garcia 19.7%. Andrew Yang has withdrawn from the race after coming fourth. The final outcome will depend on how many voters ranked each of the three leaders second or third on their ballots. If Mr. Adams falls short, New York will have its first female mayor in Ms. Wiley or Ms. Garcia.

This article from Vox provides a good overview of ranked-choice voting, including its impact on campaigning and on polarization. Worth noting that under ranked-choice voting, George H. W. Bush would have been elected to a second term and Al Gore would have been President.

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