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Andrew Kositkun Senior FX Advisor
Even though the $1.9 trillion COVID-19 emergency relief bill was only recently signed into law, market focus has already shifted to infrastructure. While the infrastructure bill will also be a large fiscal spending bill, the impact on foreign exchange and the broader market will be fundamentally different than that of the COVID-19 relief stimulus.
The recently passed $1.9 trillion COVID-19 stimulus package was designed to be income and revenue replacements and was entirely debt finance. It was also designed to use funds quickly, with 63% of the funds utilized this year and 100% of the funds utilized by the end of the next fiscal year. In contrast, the upcoming infrastructure bill should take longer to implement, be more heterogeneous in its composition, and possibly be funded by tax increases that would partially counter the fiscal thrust supporting growth. As such, while the total package will be huge, the impact on the economy and the U.S. dollar could be much different than with the COVID-19 relief bills and will be highly dependent on the exact details around timing, size, funding and composition.
Starting with timing, the legislative process for the infrastructure bill will take more time than the recently passed COVID-19 relief bill. A key question will be whether or not Democrats use the reconciliation process or take a bipartisan approach. Given that Republicans are opposed to raising taxes to fund infrastructure spending, there is an increased likelihood that the Democrats will have to use reconciliation, which won’t be available again until the 2021–22 fiscal year starting in October, thus deferring passage and pushing the economic impact into 2022. Of course, how infrastructure will be financed hasn’t been finalized, so this resolution will also be critical.
As for the components, the mixture of details that inform the multifaceted impact on the economy and the dollar remains a moving target. But here is a preliminary look at the different channels that could impact the dollar:
Aggregate demand: This is the most direct and familiar. Simply speaking, government spending increases demand and, on net, provides a cyclical boost to the dollar. But unlike the COVID-19 bill, large tax hikes are on the table as a partial source of financing and will partially offset the fiscal thrust.
Tax hikes: Beyond offsetting the demand benefit, higher taxes also act as a structural headwind to the dollar by affecting returns on capital and investment incentives and flows.
Supply side: In theory, infrastructure spending should enhance long-term productivity and potential growth in the U.S. This should offset some of the otherwise structurally dollar-negative impact from higher taxes and the increased deficits needed to finance the package.
Bottom line: Much of the fundamental impact on the dollar from fiscal spending won’t be clear for a while as the bill slowly unfolds this year. However, given than infrastructure spending will come on top of nearly $3 trillion in direct fiscal stimulus just over the past three months, the first-order impact should be to reinforce the current fiscally driven rise in U.S. exceptionalism and U.S. yields — especially if the U.S. is on the verge of full employment and Federal Reserve tapering when infrastructure funds hit. Speaking of US economic outperformance, today’s data releases included initial jobless claims of 684,000 that not only beat consensus estimates but also came in at its lowest print of the year. Continuing claims also fell more than forecasted with Q4 GDP being revised up to an annualized 4.3% from the previous print of 4.1%.
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