Bidenomics: What it Means for Rates

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Last Week: Long term interest rates and equities dipped despite US President-elect Joe Biden proposing a larger-than-expected $1.9 trillion COVID-19 relief package. The plan is designed to garner bipartisan support, but with the proposal coming fresh on the heels of a recently enacted $900 billion program, Senate passage is far from assured as many lawmakers are feeling a sense of stimulus fatigue. The yield on the benchmark US 10-year Treasury note was little changed at 1.08% after reaching 1.18% early in the week. The difference between the 2yr and 10-year Treasury yields stand at their largest in three years. 1-month LIBOR and SOFR both traded within their recent ranges, near 0.13% and 0.08% respectively. The price of a barrel of West Texas Intermediate crude oil continued to advance, rising to $52.05 from $51.65, as the US Dollar and Gold traded mostly flat. Treasury yield volatility, a key driver of the cost of rate caps and swaptions, fell steadily throughout the week.

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Biden unveiled his recovery plan. Biden’s critical first move, on which much political capital for the rest of his four-year term will depend, should be regarded as the opening bid in a long, complicated game. The President-elect plans to ask for $1.9 trillion in a package that will include $400 billion in measures directly tied to fighting the pandemic, plus a round of $1,400 checks for all Americans, as well as a doubling of the federal minimum wage, extension of unemployment benefits, and aid for states, cities, and rapid transit systems.  With wafer-thin majorities in both houses of Congress, the chance that the entire package passes in its current form is minimal.

Our Take: The more Biden can win on the most contentious issues, like a $1,400 check for every American regardless of income, the more worried the bond market will become about the possibility that such a flood of money into the US economy will stoke inflation. The greater the fears of inflation, the greater the upward pressure on long term interest rates becomes. Here is the logic: Bond investors don’t like inflation, as any real showing of it reduces the attractiveness of the fixed stream of coupon payments a bond provides. Should inflation rise in a meaningful way, bond investors would begin to sell their bond holdings, driving down prices and causing long term interest rates to rise.

So far, bond markets have reacted to the news of the $1.9 trillion stimulus package with relative calm, despite a jump in the 10-year Treasury yield above 1% after the US Senate elections in Georgia increased the chance of an expansive fiscal policy by the President and Congress. For now, we will be watching the progress of Biden’s stimulus plan closely as it works its way through Congress. Long term rates are certain to react.

Fed Chair Powell pledged he is on Biden’s side – for now.  Well, of course the Fed Chair didn’t explicitly say that he’s backing Biden’s policies, but he might as well have. In a scheduled Q&A last week, Chair Powell tamped down speculation that the Fed would taper its asset purchases – now running at $120 billion a month – aimed at keeping interest rates low, anytime soon. The last time the Fed acted to tap the brakes on its stimulus, back in 2013, bond yields spiked in an event that came to be called the Taper Tantrum. The Fed Chair went out of his way to tell markets last week that the Fed will avoid acting too early to slow its asset purchases and would likely err on the side of acting too late, and not until the jobs market improves dramatically. This means that long term rates could rise markedly before the Fed acts to slow their ascent, aiding Biden in his efforts to pass a sizable stimulus package to get the economy back on track.

Recent economic data implied that a real economic recovery is months away. A slate of uninspiring economic data showed the damage that fading fiscal stimulus and expiring unemployment benefits during an intensifying lockdown can do to economic momentum. Americans pinched pennies over the holiday season as rising COVID-19 case counts and restrictions resulted in a 0.7% decline in December retail sales, the third straight month of dropping sales. Elsewhere, consumer sentiment data showed that Americans felt less positive in their current financial situation, an expected stance as the sluggish coronavirus vaccine rollout gathers pace and government stimulus payments make their way into consumers’ hands. In an unexpected twist, consumer expectations of inflation picked up modestly. On the jobs front, initial jobless claims skyrocketed by 181k to 965k week over week, the highest level since August.

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Our take: last week’s poor economic data confirm that the consumer’s ability to fuel America’s economic recovery was running on fumes in December, hence the incessant drumbeat calls for more stimulus from the Congress and the President, and a Fed that’s implying that it will keep the foot on the gas – via asset purchases and low rates – for the foreseeable future. Unless consumers are front and center in the growth profile of the recovery, expect an ever longer slog toward normalcy than you thought possible.

What to Watch This Week: While Biden’s inauguration and Trump’s exit will garner the most attention in the days ahead, the Philadelphia Fed manufacturing index and jobless claims reports, both on Thursday hold the potential to impact interest rates in the coming week. There are no major speaking engagements from Fed officials this week, reflecting the FOMC blackout period ahead of the January 27th policy meeting.

Big Picture: President-elect Joe Biden’s eye-popping $1.9 trillion pandemic-relief plan is likely spooking centrist Democrats in the Senate and a substantial allocation to state and local governments has reliably proven a non-starter for Republicans. Given the urgency of the current crisis and the desire to achieve passage in the administration’s first 100 days, our gut is telling us that a smaller and narrower package will ultimately emerge, likely in the in the vicinity of $1 trillion, potentially with the use of budget reconciliation measures.

Even at $1 trillion, a package of that size could be enough to push economic growth above 5% this year. If we are just flat wrong and a larger stimulus package is agreed upon, growth into the 6%-to-6.5% range in entirely possible this year.

Over the longer term, loftier goals like climate change and infrastructure may ultimately occur in a later Biden-sponsored stimulus package, with the intention of presenting a stark choice to voters ahead of the 2022 midterms, which, after this week’s inauguration, will quickly come into the foreground.

Current Select Interest Rates:

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LIBOR Futures:

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Source: Bloomberg Professional

10-year Treasury:

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Source: Bloomberg Professional