More fiscal stimulus on the menu keeps market in party mode
There were record high closes for the S&P 500 and the Nasdaq on Thursday, the Dow Jones jumped by more than 1% at the close as the market reacted to news that more US fiscal stimulus is on the way.
President Biden announced a bipartisan agreement on an infrastructure stimulus plan, which could help boost growth in Q3 and beyond, after a decent 6.4% YoY growth rate in the US in the first quarter. The Bank of England meeting also delivered a surprise today, but maybe not one that the GBP bulls wanted to hear.
US fiscal stimulus – is it the real deal?
The latest boost to US fiscal stimulus is an infrastructure deal that paves the way for $1.2 trillion to be spent on upgrading roads, bridges and highways in the next 8-years. This New Deal-esque agreement includes $579bn in new spending. Congress still has to pass the deal, and US Senators need to see the details of this spending plan, but the fact that both Democrats and Republicans agree on the basic outline this means that its passage through Congress should be fairly smooth.
As we mention above, this is an 8-year deal and it is to be funded through a mixture of mechanisms including $100bn from closing tax loop-holes, Covid 19 recovery funds and from unemployment funds that have been returned by US states. Thus, the funding for the plan looks fairly solid especially since a number of Republican held states have stopped their Covid employment support programmes early, which means that money should be flowing back to Washington from the states in the coming months.
Since the plan’s funding model looks sustainable, it is unlikely to cause fiscal hawks too much stress as the plan does not include “human infrastructure” such as upgrading schools and access to health care. While this will likely anger some of the leftist, more progressive Democrats, by stripping these parts out of the plan, it was a way for Biden to win over Republicans.
The long term effect for stocks from this fiscal boost
The question some traders may be asking, is all of this stimulus good news for stocks? The initial reaction suggests yes, and if it can generate growth like we saw in Q1, then that will be positive for the US stock market. What was interesting about the US stock market reaction on Thursday was the broad-based nature of the rally after President Biden made his announcement.
Construction, mining and plant hire were the top performers after the announcement, with Boeing and Caterpillar both rising more than 2% and lifting the Dow Jones. These sectors are extremely sensitive to fiscal stimulus, so beware any sell off on the back of watered-down plans in the coming days and weeks. However, after President Biden’s big announcement this week, we think that the hurdle to getting this plan passed by the US Congress is low, and thus these sectors could benefit in the long term. Interestingly, housebuilders also gained, albeit by only 0.5%. However, this news may help that sector to reach a bottom after higher inflation and the prospect of Fed rate rises caused investors to ditch housebuilders in recent weeks.
While the prospect of tax hikes is never appetising for investors, we still think that changes to the US and global tax code will take many years to come into force, and thus fears about how this infrastructure fund will be paid for are unlikely to weigh on stock prices for now.
Momentum remains strong for stock market gains
Interestingly, the news about the latest bout of fiscal stimulus also lifted growth stocks, including the mega caps that are less sensitive to fiscal stimulus, including PayPal and Facebook, their stock prices rose by more than 1% each on Thursday. Microsoft’s stock price inched up by 0.5%, which gave the company a market capitalisation of $2 trillion for the first time. Tesla rose by more than 3% on Thursday, although that was mostly on the back of news that Elon Musk is planning to list Space X on the stock market now that it has fairly predictable cash flows, and that Tesla shareholders could get preferential access to its shares.
When a market rally is broad, it tends to mean that upward momentum is in play, which could see further gains in the short to medium term. Thus, anyone who thought that last week’s shift in the Fed’s dot plot would upend markets and cause a large sell off were misguided. We mentioned last week that the Fed sell off would be muted, while some of the losses last Friday were brutal, we think that we were proved right. The Treasury curve has remained fairly stable, with 30-year Treasury yields hovering around the 2.10% level this week, the 10-year at 1.49% and the 1-year yield, which is sensitive to the Fed’s current stance, has moderated to 0.08%.
Overall, rates in the US remain low. Although the US yield curve has flattened, the short end has remained fairly stable and has eased back slightly after last week’s “sharp” gains for yields (decline in price). This is also good news for stocks, especially “value stocks” including the construction and materials sector, which should bask in Biden’s stimulus glory for some time.
Clash of the Fed titans, good for stocks
One of the reasons why the market has recovered from last week’s taper tantrum in a relatively short period of time is that there seems to be a vigorous debate going on at the FOMC, with the hawks and the doves fairly evenly split. Bullard wants to stamp out inflation by raising rates and putting the brake on further monetary stimulus, however, Fed chair Powell said this week that inflation data alone is not enough to cause rates to rise. Of course, the latest fiscal stimulus announced by President Biden could boost both growth and inflation later this year, however, that is not a problem for traders and financial markets who bask in stock markets reaching higher highs. An undecided Fed + a US government who is willing to spend public money + better than expected jobless claims = a powerful driver for stocks, in our view.
The Bank of England plays the long game
Elsewhere, the pound was lower across the board on Thursday after the Bank of England meeting was less “hawkish” than expected. The BOE did not follow the Fed and suggest that interest rates could rise faster than expected. Instead, we believe that there are three things to note from the latest BOE meeting.
Firstly, now that Andy Haldane has left the BOE and Catherine Mann is joining the Committee, you could argue that going forward the BOE has moved from a neutral stance to a neutral/ dovish stance. Secondly, the BOE’s minutes suggest that while growth is likely to remain strong this year, the momentum caused by the economy re-opening and pent-up demand is already starting to wane. This means that the BOE is unlikely to rush into any unwinding of recent stimulus.
Lastly, the rise in Covid infections in the UK could also mean that the BOE remains cautious about removing stimulus too early. Overall, the August Monetary Policy Report and the Jackson Hole meeting, also in August, are extremely important events for the BOE and the Fed respectively, and could be seismic for markets. At that point, the BOE will know if the UK’s fast Covid vaccine roll out has done enough to keep a third wave of Covid at bay, and it should also give us some more direction on what the Fed will do next. Until then we think that GBP may not be as bullish as we had expected, and thus we could see more weakness back towards $1.39 for GBP/USD and then $1.3850, before this pair rebounds on the back of rising Covid infections hitting US shores later this summer.
The chart below shows Caterpillar’s share price. After a sell-off in June, President Biden’s announcement has helped this stock to turn a corner. We think that the latest boost to fiscal stimulus may be enough to drive this stock back to recent highs at $250 in the medium term.
Chart 1: The Biden effect