Stimulus 2021 Is More Market-Important Than 2020
The $1.9 trillion stimulus bill that passed the Senate is more market-important than its sister bill of $2.2 trillion that Congress passed in March 2020. 2020 stimulus helped cushion the abrupt fall in the economy. 2021 legislation will accelerate the economy's growth rate. The new bill adds an extraordinary scale of unnatural stimulus while jobs and income (i.e., natural stimulus) will flow from the economy's re-opening. The new stimulus bill should also accelerate the economy's inflation impulse as it comes when there is significant upward pressure on commodity and service prices.
With equities trading near all-time highs, the rise in inflation and bond yields will pressure price-earnings ratios. Federal Reserve policymakers would be wise to let the financial markets price in the growth and inflation effects. Any attempt to limit the rise in bond yields would add more fuel and momentum to the growth and inflation impulses, raising the odds of an even worse market outcome.
The Senate bill provides additional payments to people, tax-free and extended unemployment compensation, tax credits for families, money for state and local governments, other aid for housing, education & child care, low-cost loans to small businesses, and funds to distribute and administer covid tests and vaccines.
The spending impulse from the 2021 legislation could be quicker than that of the 2020 legislation, even though it is $300 billion less in total. That's because the one-time direct payments of $1400 are for low-and-middle wage earners, or income cohorts who spend more and save less out of current income flow versus other groups. Also, federal support for state and local governments, housing, and education will propel additional spending while businesses and schools re-open.
The re-opening of the economy will generate its natural stimulus in terms of job and income growth. February payrolls rose 379,000, the most significant one-month increase since October. Private (business) payrolls increased 465,000, led by a 355,000 gain in leisure and hospitality, the sector hardest hit from the pandemic. Employment in this industry is still 3.5 million below year-ago levels, and overall payroll employment is 9.5 million less. Even if re-opening the economy recovers half of the lost jobs in 2021, that would still amount to twice the average job creation for a given year.
Job creation will add hundreds of billions to natural income and spending flows, while federals stimulus will add trillions. The combination will lift GDP growth by several percentage points in 2021, generating the fastest growth in nearly four decades. That's the good news.
The fresh stimulus will exacerbate budding inflation pressures, the bad news. A super-fast commodity cycle is underway, and upward pressure on prices is also evident for a wide range of services. How much general inflation accelerates in 2021 is a hard call, but 200 to 300 basis points above 2020's rate in consumer and producer prices seems like a good bet.
From a market perspective, the upward pressure on bond yields and acceleration in inflation will be more important than the growth and profit increases. Real bond yields rise during fast growth periods. With bond yields below the inflation rate at the outset, the potential uptick in nominal and real interest rates could end up being far above current market expectations.
Federal Reserve Chair Jerome Powell and other Fed officials have been publically urging Congress to provide more economic support. With $1.9 trillion in federal spending in the pipeline and coming quickly on the heels of $900 billion injected in December, it would be wise to move to the sidelines and let market forces handicap the growth and inflation paths. Proposals to limit the rise in bond yields are short-sided: there is no guarantee they would work, and they would also negate a market interest rate tool that would help cushion the economy once the effects of stimulus fade.