US Policy Watch: Strong Fiscal Impulse, But No Inflation in Sight
The Biden administration’s policy path is primarily fiscal in nature with the US$1.9 trillion “American Rescue Plan” constituting the core of that plan. However, this coupled with a fiscal deficit of 15.8% of GDP in 2020 and a further deficit of 10% expected for 2021 has raised the specter of inflation. Yet, future inflation should be determined by the depth of the pandemic recession and upcoming fiscal plans, not the current ones.
Ahead of the US presidential election, the latter half of 2020 was full of “blue wave” investment themes, mainly on the back of expected easy fiscal policy. Thus far, this has largely turned out to be prescient, with the most market effective policy initiative deemed to be the anticipated passage of another relief bill in March. This supports the broader narrative of a strong economic recovery on the back of vaccine deployment. However, there are few substantive reasons to believe the current fiscal policy measures alone will trigger an inflationary rise. Such a scenario would require future fiscal easing beyond current plans, which should mean the backdrop for risk assets remains favorable, albeit partially priced in.
The IMF aka It’s Mainly Fiscal
The core policy plank is continued fiscal support to help the US economy gather escape velocity from the pandemic. Given parliamentary majorities and Republican positioning for the 2022 midterms, congressional reconciliation is the preferred pathway. This should lead to a wider fiscal path given that the Democratic consensus is for a more expansionary policy.
The first measure is the current “American Rescue Plan” of US$1.9 trillion, which comes on the heels of a fiscal deficit of 15.8% of GDP in 2020, thus setting our expectations for a deficit of around 10% of GDP in 2021. Given the widespread view of a strong economic recovery, these deficits are raising worries about inflation. Figure 1 illustrates the rapid increase in market pricing of future inflation, with 10-year breakevens as well as 5-year, 5-year forward yields recovering quickly from their all-time lows in 2020 to five-year highs.