Over the last couple of weeks, the Fed has managed to keep the S&P 500 elevated and close to 4000, despite the bond vigilantes beginning to flex their muscles. This turbulence may soon be over, wherein you could see the Fed leverage off the Biden infrastructure bill press conference tomorrow and reignite the markets, looking for the S&P 500 to attain the 4300 level by May.
Now, the Fed has allowed two lines in the sand to be crossed recently:
· 92 DXY / 1.195 Euro and
· 93 DXY / 1.175 Euro,
yet there has been minimal damage to the broad stock market.
However, there is a significant macro conundrum right now – will the Biden administration push for:
· jobs or
· further lockdowns.
You can’t have both. Biden and the Dems have touted “full employment” for the past month, but in the same breath they have asked states to roll back re-opening plans. These two paths are completely incompatible. On the one hand, the markets would dictate a jobs recovery to further boost demand in the economy and build momentum. On the other hand, the political operatives in the Democratic Party are worried about the 2022 midterms and digging their heels in with the hope that more Covid fear-mongering, along with promise of potentially more cheques in the post, will help mitigate House and Senate losses – everybody loves ‘free money’.
We suspect that the above is why Senate Majority Leader Schumer is looking at broadening the budgetary reconciliation process via Section 304 of the 1974 Budget Act (see below article for more information). He wants to make passing some of the big spending easier, thus ultimately helping both the economy and the politics. Unfortunately, the Biden admin is being pulled in two directions with the political component being much more powerful since their own party interests outweigh economic interests, as happened before last year’s election, when Pelosi played politics over the CARES Act 2 in rejecting the Trump administration’s $1.8 trillion October 2020 offer.
However, this creativity from Schumer may not provide the solution to passing multiple packages. There are loopholes that can be exploited by the GOP for delaying tactics, especially in the face of introducing complex tax legislation. For Schumer, threading the political needle between his party’s progressives and moderates on two functionally different bills would limit the margin for error to zero. Sinema, Kelly and Manchin cannot vote for a high spending climate change, “social infrastructure” package without significant pushback in their own respective states. Progressives alternatively, will not vote for a “shovel ready” package without curbs on pollution and social spending. The GOP will not cooperate on any of it.
Another problem for the markets emanates from Secretary of State Blinken’s disastrous talks with China in Alaska, which has left the administration with perhaps Chinese stock delistings as the only way to force Xi to the negotiating table. Unfortunately, this will also hurt the US stock market, adding more pressure on Biden from a key constituency. The Chinese will also likely retaliate in asymmetrical ways in order to pressure the US via Deere, Caterpillar, Tesla and other US companies with significant presence in China.
All in all, we believe that the likely outcome is a September-October package with minimal infrastructure spending and another round of stimulus cheques to help congressional members alleviate constituents anger over lockdowns and lack of job creation. Should this eventuate, then there will likely be more pressure on the Fed to calm the bond markets in order to avoid a risk-off correction.