Over the course of the pandemic we have witnessed extraordinary fiscal stimulus programmes from governments to secure recovery. Economic forecasting in this crisis has been extraordinarily difficult, and so has getting the size of the stimulus right. The US has gone much bigger than the rest: how we think about stimulus and policy going forwards depends on the fate of the Bidenomics experiment.
Traditional fiscal stimulus measures are designed to return an economy back towards its ordinary growth rate—to “fill the hole.” But the $4trn in additional spending proposed by the new US president would use the coronavirus crisis to shift the American economy to a higher glide path altogether.
His American Jobs Plan focuses on infrastructure spending that would boost productivity and upgrade the labour force by creating high-wage, high-hour jobs. It would invest in technology while at the same time retooling the economy for environmental sustainability. The American Families Plan, meanwhile, aims to boost human capital by supporting education and creating conditions that enable parents to work.
But to get the legislation through Congress, Biden will probably have to use a process known as “reconciliation,” which requires the measures to be deficit neutral after 10 years. The president hopes to make things add up with the American Tax Plan, which would raise corporate taxes and tax rates on the wealthy. If he cannot get as much as he needs in tax revenue, the spending side will have to shrink.
Higher GDP would be good for earnings, and therefore stock prices. But all that spending might generate inflation that erodes real returns. The rescue and relief packages passed so far have led to a rapid rebound in US growth, forecast to rise as much as 7 or 8 per cent in 2021. This has created shortages that are pushing up inflation. US consumer prices rose at a 4.2 per cent annual rate in April, while the prices-paid component of the ISM manufacturing index rose to the highest level since 2008.
Federal Reserve officials predicted this spike, and think it should fade. But they worry about inflation expectations becoming unanchored—people assuming price rises will accelerate and demanding higher wages in return. The University of Michigan Inflation Expectations survey of consumers found the median expected price changes for the next five years jumped from 2.7 per cent at the end of April to 3.1 per cent in mid-May, a level not seen since 2011. If these expectations start ratcheting up, the US central bank will need to hike rates to tamp down inflation, without overdoing it and pitching the economy into a recession. The Fed has a poor record of engineering such soft landings during rate-hiking cycles.
So far however, despite the University of Michigan’s survey, market expectations reflect the Fed’s view: inflation will rise over the next year or two, but then settle back. That sets the stage for investors to place their bets on Bidenomics. Much of the spending is spread over 10 years, so it shouldn’t result in a dramatic, sustained spike in prices and bond yields will remain contained. Given the US is the country going biggest on fiscal stimulus, the dollar should remain strong. There may be some volatility, but from current valuations, US share prices should continue to outperform global equities. Thus far Bidenomics is no reason not to buy American.
