Biden’s Fiscal Reflation

11 January 2021 (5 min read)

Key points

We finally have a clear picture of the parliamentary parameters for Biden’s economic policy. The fiscal push may be a headache for the Fed, and we expect market pressure on the central bank to peak when we reach collective immunity. However, in the meantime, business conditions will first deteriorate further given the bad news on the pandemic front.

The US elections finally seem to be over, and beyond the striking pictures of the capitol under siege, the certification process has been completed, a new administration will take over on January 20th and the Democrats will command a slim majority in the Senate. This has triggered a re-appraisal of long-term interest rates in the US which have broken above 1% on the 10-year maturity, while the equity market remained buoyant. By and large we think this market’s reaction is rational. We explore here the likely shape of Biden’s economic policy under the final parameters. Even if the new President will face some hurdles in pushing his agenda through – we should have in mind the difficulty Barack Obama had to get his healthcare bill in despite a much more comfortable parliamentary majority – we think that the enhanced emergency stimulus, going beyond the USD 900bn package agreed between the two parties just before the festive break, will be implemented. While some components of Biden’s medium-term platform look very difficult to pass, in general we expect a further rise in public spending above and beyond the 2021 push. The medium-term spending strategy is supposed to be fully offset by higher taxes, but we think the likeliest outcome is a rise in the deficit. The enhanced stimulus – probably ending up a c.10% of GDP – may be a headache for the Fed. Its forward guidance is consistent with more monetary easing if the macro situation deteriorates, but assuming the new package fully offsets the impact of the stubborn “winter wave” of Covid, contrary to the ECB the Fed has not explicitly pledged to fight any “unwarranted tightening in financial conditions” which the market would bring about. The rise in the supply of US treasuries will not necessarily be met by a faster pace of bond buying by the central bank. We expect market pressure on the Fed to peak by the time “collective immunity” is finally achieved and the economy goes through another spectacular, albeit transitory, rebound. However, in the short run, business conditions are likely to deteriorate further given the latest pandemic data. The emergence of the “UK variant” is a particular concern.

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