US fiscal stimulus marches forward

Morgan Stanley with the note:

As Congress reconvenes, we expect progress to our base case of more fiscal expansion and identify key risks to our view. Recent news on spending plans offer hints on bill structure. We adjust our deficit growth estimates to~$1tr over five years and~$1.5tr over 10, but as low ramp in year 1.

Our base case has been and remains that Congress will approve a sizeable fiscal expansion. In particular, we see multi-trillion dollar increase in federal spending for the next 10 years, which will only be partially offset by tax increases thus leading to a substantial fiscal expansion.

Events in recent weeks are tracking with that view, but execution risk is substantial. Upcoming events will put our basecase to the test.

This underscores another important consideration–that Democrats’ legislative strategy increasingly reflects a dynamic of ‘all or none’ outcomes for fiscal policy size (i.e.,that,if approved,total spending levels are more likely to end up near the proposed top line than some halfway point).

In addition to approving the bipartisan infrastructure bill (see more detail here), the Senate two weeks ago also passed a FY2022 budget resolution, a first step to beginning the reconciliation process and enabling up to $3.5tr of new spending relative to the current budget baseline. This has prompted the House of Representatives to reconvene this week, with Speaker Nancy Pelosi indicating that both the bipartisan bill and the budget resolution will be considered.

We’re likely to remain confident in our base case if Democrats overcome a key internal disagreement and pass a budget resolution that mirrors the Senate’s $3.5tr plan. In particular, investors should watch closely the procedural debate between a group of House moderates and Speaker Pelosi. Last week, a group of nine moderates wrote a letter to Speaker Pelosi expressing their opposition to moving forward with both pieces of legislation simultaneously, urging instead a vote on the Senate-passed bipartisan infrastructure package before the chamber takes up the budget resolution and subsequent reconciliation bill. In our view, Speaker Pelosi has indicated she will maintain her initial plan, moving both pieces of legislation along together, which implicitly requires the House to first approve the budget resolution to keep the drafting of the $3.5tr plan on track. If moderates stay true to their demand, the fiscal process could stall.

Our base case has been and remains that Congress will approve a sizeable fiscal expansion. In particular, we see multi-trillion dollar increase in federal spending for the next 10years, which will only be partially offset by tax increases thus leading to a substantial fiscal expansion. Events in recent weeks are tracking with that view, but execution risk is substantial. Upcoming events will put our base case to the test. This underscores another important consideration–that Democrats’ legislative strategy increasingly reflects a dynamic of ‘all or none’ outcomes for fiscal policy size (i.e.,that, if approved, total spending levels are more likely to end up near the proposed top line than some halfway point).

A few points:

  • This is why I remain confident of an ongoing DXY bull market across the cycle. This is a 0.5-1% growth advantage for the US versus the last cycle. It means stronger inflation and yields than elswhere.
  • But, most of the spending is NOT commodity-intensive, rather it sis human infrastructure.
  • So, as China slows into its structural reform, the US does not provide anywhere near the offset needed to support commodity prices that will already be under pressure from a strong DXY.
  • This is an awful scenario for EMs as a rising DXY sucks away capital and falling CNY sucks away tradableable goods.
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