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Biden administration: two shots at stimulating growth

Following the run-off ballot in Georgia, the US government can count on a congressional majority. This paves the way for greater fiscal stimulus. However, the government’s slim majority will limit its leeway for tax hikes and tighter regulation. This will create a very favourable environment for risk assets such as equities.

On the day that Trump supporters stormed the Capitol in Washington to try to stop the certification of Joe Biden’s victory in the US presidential election, the equity markets made gains. This was because the balance of power in the US had been decided, despite the political turmoil. The Democrats’ win in the run-off ballot for two Senate seats in the state of Georgia means that the Biden administration will now have a majority – albeit a very slim one – in the two houses of Congress (Senate and House of Representatives). In the end, Biden’s election victory was confirmed by Congress with only a few hours’ delay. The markets have been ignoring the deep schism in US society embodied by the events in Washington.

One of the main reasons for this is that investors now have greater certainty in some regards, resulting in a fall in risk premiums. This can be explained as follows:

  • The Biden administration is able to take action. Biden has the legislative mechanisms in place that he needs to forge ahead with his economic and socio-political agenda. Without a parliamentary majority, President Biden would mainly have to govern by means of executive orders, which offer less legal certainty.

  • The administration should also be able to increase expenditure, not only to boost consumer spending but also to stimulate investment. This includes the transition of the economy from ‘brown’ to ‘green’ and support for innovative technologies, which may increase the US economy’s potential for growth in the long term.

  • The pressure to compromise is high, which should result in moderation in terms of outcomes. In the smaller house, the Senate, 50 Democrat seats will be matched by 50 Republican seats. The Democrats will only have the upper hand because the future US Vice President, Kamala Harris, will be the Senate President and have the tie-breaking vote. Biden is therefore reliant on broad support from his party. He will only have a majority if the more conservative Democrat senators are on board. This will significantly limit his options, for example when it comes to tax increases. In many cases, he will also be dependent on the backing of at least some of the Republicans because 60 votes are required for Senate approval.

  • The Senate can reach decisions with just 50 votes once per fiscal year (at the end of September). This is when it decides on income, spending and the debt ceiling as part of the budget reconciliation process. This ‘insurance policy’ gives the administration two shots at obtaining approval for major investment plans and support programmes this year without the help of the Republicans because a budget reconciliation for the current fiscal year (at the end of September) and one for the following fiscal year would be possible.

President Biden can govern

with the slimmest possible majorities in Congress

President Biden can govern
Source: Union Investment, as at 19 January 2021.

On the whole, it seems that the Biden administration will exercise moderation in its decision-making. Overly strict regulatory changes are unlikely, and the planned tax increases for companies will probably be modest too. However, a potential legislative stalemate has been avoided, opening the door for more economic stimulus and infrastructure programmes. A potential adverse impact on US companies has therefore become less likely. On the other hand, a further sharp rise in debt as a result of high spending has been curtailed.

Forging ahead with budget discussions

What happens next in terms of fiscal policy? Biden presented his American Rescue Plan on 14 January. It addresses the short-term effects of the pandemic, for example by extending support for the unemployed, giving out further stimulus cheques, and providing funding to tackle the pandemic at state and local level and in smaller firms. The first draft of the budget for the next fiscal year (which starts in October) is expected to be submitted in February as a basis for discussion and will reveal the outline of Biden’s longer-term economic programme.

This will probably set out further aspects of the spending plans, for example on infrastructure and, potentially, planned tax hikes. Democrats and Republicans should have a chance of agreeing compromises because some of Trump’s tax measures will expire at the end of 2021. These have been favourable to companies, and the Republicans would like to extend them. Tax relief for the middle classes may be offered in return, although wealthy households would face increases. A staggered, gradual reform of corporate taxation could also be introduced as part of this package.

A good environment for the capital markets?

The environment for risk assets, particularly equities, is therefore likely to be very positive because there will probably be fewer tax hikes while economic conditions remain difficult. In the longer term, greater potential for growth on the back of modernisation of the economy, combined with gentler rhetoric in trade disputes, should lead to a moderate fall in risk premiums. The appointments to Biden’s administration also point to frictionless cooperation between the US Department of the Treasury and the US central bank, the Federal Reserve. A source of risk, however, is increased political confrontation between the Democrats and Republicans.

US: economic recovery combined with slight rise in yields

US: economic recovery combined with slight rise in yields
Sources: Refinitiv, Union Investment, Bloomberg, as at 20 January 2021.

The bond markets are likely to be influenced by the degree to which any investment programmes are financed with debt. Only some of the higher spending is likely to be funded from higher taxes, which means there is likely to be new borrowing and an increase in supply in the US Treasuries market. The US yield curve is therefore likely to steepen a little further at the long end. The Fed would probably counteract this by stepping up purchases of longer-dated bonds. So far, the rise in yields at the long end of the maturity spectrum has remained roughly on a par with the rise in inflation expectations. Interest rates at the short end are still firmly entrenched and real rates of return remain at historically low levels, especially in the short-dated range.

This supports the equity markets. Opportunities will open up in more cyclical sectors and in areas where technologies of the future or environmental, social and corporate governance (ESG) factors play a significant role, particularly in view of the potential disclosure of climate risks in corporate reporting and an increase in financial support. Traditional energy companies and the coal industry are likely to be on the losing side. Regulation in the pharmaceutical sector is expected to be moderate at most and will probably lead to changes such as the expansion of Obamacare rather than extensive pricing rules. Regulatory changes in the financial sector are unlikely to be high up on the agenda, which means this sector will benefit from what is anticipated to be a small degree of reflation, i.e. widening profit margins.

Technological dominance still a controversial topic

The dominance of big tech companies in the IT sector is likely to remain a huge issue. However, action will continue to largely be restricted to antitrust lawsuits. The big tech firms’ future merger & acquisition activity is expected to come under much greater scrutiny from regulators. As regards trade policy, Trump’s executive orders and tariffs are unlikely to be withdrawn any time soon, particularly as some aspects of them can be used as bargaining chips.

In fact, competition in the tech sector will probably become much more strategic and focused. However, the hardships for companies created by the restriction of sales markets are expected to be at least partly mitigated by investment incentives in the domestic market. And on the currency front, the US dollar may benefit indirectly from rising yields on Treasuries.

 

As at 20 January 2020