While the Georgia runoff elections represented a watershed change to the 2021 macro outlook due to expectations for additional fiscal spending, events over the past two weeks also provided additional catalysts for upside risk on the U.S. fiscal outlook.
Specifically, markets are focused on the Biden administration’s ambitious “rescue and recovery” plan and indications that President Biden will be front-loading his $4 trillion Build Back Better plan. Additionally, comments from Treasury Secretary Janet Yellen, during her confirmation hearing, which made an argument to aggressively expand deficits to provide immediate economic relief and finance investments in the U.S. economy while downplaying the need to raise taxes in the near term, have also caught the markets’ attention.
While all these plans are growth positive, passage through the Senate would require support from either 1) 10 Republicans plus all Democrats to pass with a filibuster-proof majority or 2) all 50 Democrats to pass through reconciliation. As such, Biden will need to win over moderate senators to pass his economic agenda.
Among the Democrats, the main moderate to focus on is Sen. Joe Manchin of West Virginia, who advocates for fiscal conservatism and has a history of bucking the party trend. Notably, Manchin voted against his party in the last Congress on multiple economic issues. That said, Manchin has expressed support, in recent interviews, for additional targeted stimulus checks and an infrastructure bill in the $2 trillion to $4 trillion range over 10 years.
Elsewhere, Democrat Sens. Tom Carper and Jon Tester have voted against budget increases in the past, citing deficit concerns, with Sens. Kyrsten Sinema and Angus King pushing back against the most progressive policies on climate change and green initiatives. Mark Kelly, the newly elected senator from Arizona, is a bit of an unknown quantity, but based on his campaign, he appears less likely to support wholesale reform, like the Green New Deal and Medicare for All, and more likely to support more moderate policies, such as tax credits for green infrastructure, limiting the amount of regulatory change that could happen over the next two years.
Looking at the Republican side, it should be difficult for Biden to find 10 senators who will cross the aisle to pass the more progressive elements of his agenda. It is possible that some moderate Republicans could be persuaded, but only Sens. Susan Collins, Lisa Murkowski and Mitt Romney have voted against the Republican majority more than the average senator. Midterm elections could also play a role, meaning Murkowski could be less likely to cross the aisle, as she is up for re-election in a deep red state, but purple state senators, such as Rob Portman and Chuck Grassley, could be in play.
In the end, it appears it will be difficult for Biden to pass his stimulus in bipartisan fashion, so the use of reconciliation appears likely. With Democrats holding the slimmest of majorities in the Senate, the Biden administration can’t afford to lose a single Democratic vote for reconciliation to work. This means moderates will control the process, leading to a smaller stimulus package with progressive elements watered.
Global Perspectives is now available as a podcast.
In this week’s Global Perspectives podcast, we discuss developments in Japanese politics and how that can ripple throughout the financial world. It is easy to get distracted when our domestic financial markets are full of volatile short-term trading structures and musings about generational change in how we trade US stocks. But we need to keep an eye on Japan, as there has been a resurgence of Covid-19 and hopes for keeping the Olympics on track for this summer are starting to look shaky.
One- to two-week view: The euro (EUR) should remain range bound in the near term amid a lack of major changes in the current market narrative. Expect markets to remain cautiously risk-on, thus U.S. dollar (USD) negative, given hopes for additional fiscal support in the U.S., no major change in U.S. tax policy in the near future and Fed Chair Jerome Powell’s confirmation of low rates for now. Notably, European growth continues to lag U.S. growth on the back of extended or tightening restrictions in Europe. As such, a material rise in EUR/USD back to its December highs appears difficult. On the monetary front, European Central Bank (ECB) officials have pushed back on EUR strength, noting that there are many tools to combat EUR appreciation and that markets are underestimating the odds of further rate cuts.
Three- to six-month view: With the factors that pushed the EUR higher in 2020 having faded or starting to fade, gains in 2021 should be harder to come by. Moreover, the prospect of more U.S. fiscal stimulus has helped U.S. yields move higher, challenging the view that rest of the world growth could outpace U.S. growth. Near-term optimism on a recovery in global growth helps the EUR higher, but the single currency should dip into year-end as U.S. yields rise, the ECB continues to fight deflation and market focus shifts to questionable domestic growth fundamentals. In essence, it is difficult to see a sustained EUR rally without European economic exceptionalism and the prospects of ECB rate hikes.
One- to two-week view: The pound should continue to benefit from global risk-on and the U.K.’s lead in vaccine rollouts. Economic data, including softer retail sales and disappointing labor market and PMI numbers, indicates that the third national lockdown is having a greater economic impact than the second lockdown. As such, additional fiscal and monetary stimulus is expected in some form. On Brexit, the economy continues to adjust to new border frictions, but this was always expected. Further details on services negotiations between the U.K. and the EU will ultimately be an important driver for sterling’s post-Brexit trajectory, but near-term price action should revolve around the race between the vaccine and increased infections.
Three- to six-month view: The path for the pound in 2021 will depend on the interaction between the realities of Brexit and the speed with and extent to which the U.K. economy can recovery from the pandemic. On the pandemic, the U.K. is in its third lockdown, which puts first-quarter GDP in danger of contracting. However, the country is leading most other countries in the pace of its vaccination program, putting the economy in a relatively strong position to recover sooner than its peers. But the prospect of economic outperformance is hindered by persistent headwinds from what is a relatively unfavorable trade deal that largely ignores the U.K.’s important services sector. Certainly, the pound is a weak currency compared to historical standards, but weak doesn’t always mean cheap, as the negative consequences of Brexit warrant a discount. This is why the pound is expected to drift lower as markets refocus on the fact that a skinny deal is still a fundamentally bad development.
One- to two-week view: USD/JPY should be primarily driven by overseas developments as markets wait for clarity around the Bank of Japan’s upcoming policy assessment due to be announced in March. While the backup in U.S. rates could dampen near-term yen gains, the core view remains to add on rallies, as USD/JPY should continue to move lower due to Japan’s real interest rate advantage and a relatively cheap yen versus the current level of yields. Overall, USD/JPY appears to be stuck between a rock and a hard place, as U.S. 10-year yields remain above 1%, but arguments for a weak dollar continue to swirl.
Three- to six-month view: The move higher in U.S. yields has interrupted what was a fairly linear decline in USD/JPY. Nevertheless, the medium-term view on the yen remains informed by inflation-adjusted rate differentials that support continued yen strength. Japan’s second state of emergency should result in increased headwinds for growth and inflation. As a result, real yield spreads and relative U.S.–Japan inflation expectations continue to support yen strength.
One- to two-week view: An upbeat outlook out of the central bank due to the positive effects of an earlier-than-expected vaccine rollout has helped the CAD but the near-term outlook remains choppy and capped by the course of the virus. Given this, extended fiscal support, accommodative monetary policy and encouraging news on the vaccine front should keep the economy supported and prevent a collapse in sentiment. As with the Fed, expect the Bank of Canada to push back on any premature expectations for QE tapering. Expectations for additional fiscal stimulus in the U.S. also bodes well for Canada given its integrated supply chains. Bias remains for further loonie appreciation.
Three- to six-month view: The loonie should remain driven by market sentiment and is expected to continue to strengthen through the year as domestic factors continue to improve. Specifically, Canada’s domestic outlook has improved due to improved odds for U.S. fiscal stimulus and its spillover effects. In essence, Canada’s proximity to the U.S. and correlation between longer-end U.S. and Canadian yields should see Canada benefit more than its DM peers. While the Canadian energy sector will feel some pain from the elimination of the Keystone pipeline, the improved global outlook and actions from OPEC+ give support for the outlook on oil and should allow the Canadian energy sector to benefit without being tethered to OPEC+ production constraints.
One- to two-week view: Growth indicators continue to point to a continued recovery in the Chinese economy. Relative economic outperformance, a current account surplus and relatively high yields form the base for a bullish view and support a continued drift lower for USD/CNY. Eventually, COVID-19 vaccine distribution will allow the rest of the world to close the growth gap, but a persistent yield advantage and strong foreign investor inflows support further gains. Recently, Chinese official take several steps to limit capital inflows and promote capital outflows, signaling their concern over yuan strength. Nevertheless these steps should only slow, not reverse, the current trend.
Three- to six-month view: Yuan strength has extended into 2021 largely as expected and should continue, with appreciation driven by supportive fundamentals and solid fund inflows. China’s export sector has outperformed, and an imminent reversal of this is unlikely given the global COVID-19 situation and the slower-than-expected vaccine rollout. On the flows front, bond inflows remain solid and should continue given China’s relative yield advantage. Recent weaker-than-modeled yuan fixings have garnered some attention, but it’s too early to extrapolate this into a shift in policy stance, as the People’s Bank of China is expected to remain accommodative to support growth for the foreseeable future.
One- to two-week view: Consolidation appears to be the name of the game, as the move higher in U.S. rates has stabilized. The Reserve Bank of Australia (RBA) meets this week and will update its forecasts. Expect the bank to highlight flexibility, with the QE program likely to be extended. Spare capacity and a strong Australian dollar (AUD) likely means it’s too early to signal anything on taper, even with better economic data. As long as markets continue to look through near-term risks and toward medium-term optimism, the USD should weaken and the AUD should remain supported.
Three- to six-month view: Recent price action has been driven by strength in key commodity prices, with iron ore being a particularly important catalyst. However, the bias remains to see the currency move lower as the real yield compression story runs out of steam and the USD gains support from additional fiscal spending. Regarding trade, Australia–China trade tensions should continue to linger, but critically, China is not expected to put restrictions on iron ore due to the lack of alternative supplies. Finally, the RBA has historically been more concerned with relative performance than absolute levels. Therefore, while currency level is not optimal, it is unlikely to be a major monetary policy consideration in the near term.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain unchanged at 0.10%
Expectations for rates to remain unchanged at 0.10%
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
U.S. Manufacturing PMI
Expectations for a 60.0 print
U.S. ADP Jobs Report
Expectations for a 50,000 print
U.S. Initial Jobless Claims
Expectations for an 850,000 print
U.S. Non-farm Payroll Report
Expectations for a 55,000 print
Canadian Jobs Report
Expectations for a 40,000 print
EZ Unemployment Rate
Expectations for the unemployment rate to remain unchanged at 8.3%
EZ Q4 GDP
Expectations for a 1.2% quarter-over-quarter decline
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