The Welcome Party for President Biden
The market has celebrated the changing of guard at the White House as it expects nearly $1.9 trillion worth of new stimulus, although most likely the final amount will come in south of $1 trillion. What the market tends to forget is that in US politics talk is cheap, action extremely difficult – especially with the slimmest of majorities in Congress for the Democrats.
Unlike most commentators, I don’t believe President Biden offers a robust vision for dealing with the critical issues at hand in the US, from inequality to its structural deficits. His back-to-normal agenda is both flawed and entirely lacks vision. Sure he is nice and talks a good game on the need for national unity, but the US doesn’t need a nice President, it needs a visionary President and the oldest President ever conditioned by a lifetime of his past five decade in politics, is not likely to be that person.
Interest rates matter
All of the markets today are counting on one thing and one thing only: low interest rates. But we firmly believe rates at the longer end of the yield curve will rise, even as central banks keep short rates pegged near or below zero. The US 10-year treasury benchmark could easily rise above 150 bps. Why?
The equity market is one large bond with a huge duration of 20! – For those unfamiliar with the implications of duration, this means that a 100 basis point, or 1% move in the yield will cost at least 20 points (percent). That is a yield-sensitive market and the US 10-year benchmark already has risen from lows last August near 50 bps by 60 bps to the current level of 1.10%
The need for social stability has replaced the need for financial stability as the key macro policy response. This means that from here, stimulus will be aimed at the pockets of consumers and small businesses rather than large corporations. It means massive spending increases for the common good in terms of welfare, education and health, but also for infrastructure and the Green Transformation.
This then translates into Supply Side Bottlenecks where the physical world is too small for the digital economy and online economy to continue to scale at the same pace as previously. You can have the best online platform in the world, but you still need to: produce your goods (China), where factories now wants an additional 15-25% to deliver the order you put in 2020. Then when you get the goods you need to ship them from a Chinese port. Good luck. Container rates are up 400% to 600% depending on port of delivery, and when you then finally get the goods delivered in your distribution center, the cost for the final mile of delivery has risen by some 50% in places on capacity constraints!
In other words, business-to-business inflation is rampant. Consumer demand will continue as stimulus will be aimed at driving that demand. Inflation is here.
The chart below suggests that the market is increasingly concerned about the arrival of higher inflation, as the Breakeven Rate – the difference between the yield on a basic 10-year US Treasury versus the yield on an inflation-linked treasury – is well over 2%.