For all the attention on the Fed, don't forget Congress and fiscal policy counts too

The unelected members of the Federal Reserve may wield the authority to adjust interest rates, like they did Wednesday with their momentous 50 basis point rate cut that sent stocks soaring. But it’s the Congress that holds the so-called “power of the purse,” and at some point those muscles will be flexed.

Likely not until after the next President is chosen, mind you. But wealth managers still better not forget who controls the power over government spending - and the impact it may have on their best laid plans.

“I think Congress is critical, especially after the election,” said Ed Al-Hussainy, senior rates analyst at Columbia Threadneedle Investments. “At the moment, fiscal policy is roughly neutral. It's not really adding an accelerant to the economy the way it was several years ago. It's roughly flat. It's giving the Fed an opportunity to slow the economy and squeeze inflation out of the system.”

“Next year, that equation starts to change quite materially depending on who controls Congress,” added Al-Hussainy. 

Meanwhile, Mabrouk Chetouane, head of global market strategy at Natixis Investment Managers, says investors need to bear in mind that fiscal policy so far has been a massive support for the US economy. The key question, in his opinion, is if this fiscal support will continue in 2025.

“There's a debt ceiling that will come immediately right after the elections in January 2025. And I think the market will be extremely sensitive to the issue to the outcome of this debt ceiling negotiation. So in my opinion, it's too soon to say that this is a negative point for the market, but definitely it will be in the coming months,” said Chetouane. 

For those that may have forgotten, the debt ceiling was suspended altogether back in June 2023, when President Biden signed the Fiscal Responsibility Act of 2023 into law and the national debt was just over $31 trillion. That suspension will remain in effect until January 1, 2025 and Uncle Sam’s debts are now over $35 trillion.

Not to make things sound more dire, but last week House Republicans pulled their plan to avert a government shutdown. That means the attention on Congress will only heighten in coming months to do something, anything about the issue. Meanwhile, the two Presidential candidates continue to ignore the problem of the national debt even if one of them will soon be inheriting it.

“I don’t know if anyone from either party thinks that Congress will cut spending since neither party in over 25 years has shown they have been able to do that,” said Daniel Lash, certified financial planner at VLP Financial Advisors. “If spending cuts are put into place with the next budget, then it is likely that the areas in which spending cuts are indicated will affect stocks in those sectors. So if they reduce defense or pharmaceutical R&D spending then in the short-term you are likely to see stocks in these sectors that are more reliant on government spending to go down.”

Added Lash: “If they spend more, which Congress seems to have no problem doing, then - depending on the level of increase - we could see this lead to a rise in inflation. But it would likely take 6 to 12 months for that to be seen in the economy.” 

Jeff Muhlenkamp, portfolio manager at Muhlenkamp & Company, is not waiting around, however. Despite the Fed’s recent proclamation that the war on inflation has been won, he believes the Federal government continues to overspend and is not showing any signs of slowing. In his view, this will only restoke the inflationary fires.

“That will start to be reflected in interest rates and in inflation as they devalue the dollar so they can afford what they've borrowed. That's really what the 70s were about. We think it's entirely possible and maybe likely that we see another period of time like that,” said Muhlenkamp, who is buying gold mining companies and energy shares, both of which were big winners in the disco decade.

Finally, Eric Amzalag, CEO and founder of Peak Financial Planning, says he hasn’t had much time – or inclination – to follow the goings on in the Capitol.

“Truth be told - the presidential election, retail spending data, consumer sentiment, employment reports, and fed policy decision have claimed my entire focus. Fiscal policy has always been a distant priority in effecting my decisions with client portfolios - fiscal policy is mostly political theater - both parties will end up deficit spending in my opinion,” said Amzalag.