It has been, by any reasonable measure, an eventful first quarter. At the start of the year, the pandemic was raging and vaccines had barely begun to roll out. Today, despite a recent tick up in cases, the light at the end of the tunnel is looking brighter and closer. At the start of the year, a very contentious election seemed destined to be followed by political gridlock. Today, with Democratic control of the White House and both houses of Congress, aggressive fiscal policy is set to boost the pace of economic recovery and the risk of inflation. At the start of the year, 10-year Treasury yields were below 1% and equity valuations looked high. Three months later, interest rates have seen a significant increase and, while value has, for once, led the market, overall equity valuations have risen further, with the S&P500 closing at a record high on Friday, up 5.8% for the year so far.
However, despite all of this, the United States and the World remain in waiting mode. The distribution of vaccines, while having a clear impact on reducing fatalities from Covid-19, has not yet progressed enough to allow society to return to normal. Fiscal stimulus is beginning to show up in wallets. But how much will be saved, how much will be spent and how it will impact growth and inflation remain unclear. Numbers this week and in the weeks ahead should provide some answers to these questions. However, in the meantime, it is worth taking a survey of just where we are in the calm before the surge.
On the pandemic, the last few weeks have seen first a stalling out and then a ticking up in new confirmed cases along with a continued sharp decline in fatalities. This is not surprising, since the decision to vaccinate the elderly first was always more likely to reduce mortality than infection. However, the pace of vaccination is continuing to increase, now running at a seven-day moving average of over 2.7 million administered doses. This, combined with those who have acquired some immunity by catching the disease, still suggests that the country should approach herd immunity by the start of the summer, although it will still take some time before both families and businesses can truly logistically and psychologically adjust to a post-pandemic world.
On fiscal policy, according to media reports, the Administration appears to be adopting a two-track approach to its domestic policy agenda (Source: White House eyes tax increases on companies and the wealth to fund infrastructure, setting up clash with GOP, Washington Post, March 23, 2021; Biden Plans to Split Spending Plan in Two, Wall Street Journal, March 29, 2021). On Wednesday, President Biden will lay out his plans for infrastructure investment in a speech in Pittsburgh. While the address will likely focus on rebuilding transportation infrastructure and green technology, investors will have equal interest in tax increases proposed to pay for part of the plan. This could involve raising the corporate income tax rate from 21% to 28% and increasing the minimum corporate tax on foreign profits.
The Administration is also intent on extending its efforts to reduce inequality and help with the child and dependent care expenses with a view to making it easier for women to enter and stay in the work force. The President is likely to provide more clarity on these proposals next month. This could be partly funded by higher taxes on personal income and capital gains for upper-income individuals as well as an expansion of the estate tax.
There is, of course, great uncertainty about what the President may propose and even greater uncertainty about what Congress may be willing to pass. However, if the legislation is successfully maneuvered through Congress, it will probably be via the reconciliation process requiring just 50 Senate votes. It is also highly likely that this legislation will only be partly paid for through higher taxes and with funding trailing behind spending, allowing for a further extension of substantial fiscal stimulus into 2022.
On economic growth, data last week continued to suggest only moderate growth in the first quarter, with real GDP likely to rise at close to the 4.3% annualized pace of the fourth quarter. However, consumer and business sentiment readings were strong and this trend is likely to be repeated in this week’s readings on consumer confidence on Tuesday and global PMIs on Thursday. Light-vehicle sales for March will likely show a healthy increase, in a first sign of the impact of fiscal stimulus on consumer spending. However, low inventory levels, reflecting supply chain issues, may impede a surge in vehicle sales, leading to strong gains in prices as well as volumes. This is likely to be a broader theme throughout the rest of the year, as supply struggles to keep pace with surging demand. Despite this, real GDP will likely recover the last of its pandemic losses in the second quarter and could easily match the Fed’s forecast of 6.5% year-over-year growth by the fourth.