Bidenomics

Economists’ failure to accurately predict the magnitude of big events like booms and recessions and – perhaps more often than they’d like to admit – the timing of these events with sufficient foresight, inevitably makes them the target of all sorts of jokes: for example, how can you tell that economists have a sense of humour? Because they put decimal points in their forecasts. While eating humble pie is a valuable lesson in the business of forecasting, sometimes just spotting the underlying trend turns out be quite helpful – and heroic enough. The economic policy of US President Joe Biden suggests that one such trend is in full swing: large-scale fiscal stimulus and various redistributive tax measures in the context of ongoing monetary easing. To what extent this boosts economic and earnings growth, and whether asset prices already capture the full impulse, is highly uncertain. But, directionally, this shift is highly positive for the recovery and reflation trade.

How to spend it: Biden’s $2.3 trillion American Jobs Plan and $1.8 trillion American Families Plan are different aspects of a large-scale stimulus programme with the objective to boost investment in areas ranging from human capital to infrastructure and sustainability but, also, with some redistributive aims. In part, the US is playing catch-up with its peers: the pledge to achieve a 50-52% reduction in net US greenhouse gas pollution by 2030 isn’t that different from the commitments of the major European countries; the shift towards extra spending on infrastructure puts the US closer to other advanced economies. In part, though, both size and speed of these key policy changes – all announced during Biden’s first 100 days in office – are remarkable. Importantly, our base case is that the US should continue to grow rapidly over the next few quarters without overheating.

How to pay for (some of) it: Even though the net fiscal impulse will likely stay quite expansionary, the proposed capital gains tax hike to 39.6% – the top marginal income tax rate under Biden’s proposal – would move the US towards the top end of the international range. Adding the 3.8% tax on net investment income that Congress established in 2009, the combined rate would be 43.4%. Even a more modest expectation of a smaller increase to less than 30% would move the US combined rate into the top half of advanced economies. The Tax Policy Center estimates that such a policy would raise around $370 billion over ten years. At this juncture, it seems probable that at least a few Democrats will raise concerns about the impact on family businesses. In our view, it’s possible that any capital gains tax increase that ultimately gets approved is the result of a compromise.

Here’s why this matters:

Reflation thesis still in play: Despite fresh highs in global equities, we still think that the full strength of the growth recovery that we forecast hasn’t been fully reflected yet. In line with our view that periods of rising bond yields will likely alternate with periods of rising prices for riskier assets, Treasury yields pushed to new highs in March – causing some wobbles in equities – while equities led the way in April, helped by meaningful bond relief. Although March’s equity drawdown and the bond rally that followed have led to questions over whether the reflation trade is losing momentum, we think both equities and longer-dated yields will probably make fresh highs as strong economic data clash with policy dovishness. Given the back and forth between these two legs, we still think equities should stay well underpinned, but with occasional bouts of volatility going into the summer.

Fed pricing still too hawkish: Despite booming growth data (apart from the payroll miss last Friday) and rising inflation, bond yields have moved sideways over the last few weeks. Markets are pricing inflation above the Fed’s target in both 2022 and 2023, around three policy rate hikes by the end of 2023 and a decent chance of a hike as soon as 2022. Given our forecast for the trajectory of US inflation and our understanding of the timeline for the Fed to taper its asset purchases, this pricing strikes us as hawkish, though we think it’s unlikely to come out of the yield curve to a significant extent while market inflation expectations remain high. However, more stability may attract carry-oriented demand. At the back end of the curve, we still see risks of rising yields as and when the central bank announces that it will taper its asset purchases.

Meanwhile, another big data week…

Riding the inflation spike: While there’s no obvious statistical distortion that can explain the large US payroll miss last Friday, we think that firms were perhaps keener on bringing back their pre-crisis workforce than on expanding their businesses. Continued reopening should support the labour market. Sizeable base effects are likely to lift the US headline inflation rate above 3.5% and close to 2.5% for the core measure. Hotel lodging rates are rising, along with airfares and price categories related to vehicle travel such as cars, trucks and insurance. UK GDP should have contracted outright in the first quarter, but more recent indicators point to positive growth – as acknowledged by the Bank of England’s forecast upgrade and unexpected decision to slow the pace of asset purchases last week. In Europe, the ZEW survey should provide an early sentiment gauge for May.

Daniele Antonucci | Chief Economist & Macro Strategist