At the end of April, US president Joe Biden marked his 100th day in office. It has been a busy few months for the new administration, and since the Democrat leader’s swearing in, we’ve seen a raft of ambitious targets and pledges – including a huge stimulus bill and promises to prioritise climate action and infrastructure. But what is the outlook on these plans? And what can we expect to see in terms of monetary and fiscal policy, as well as long-term inflation?
A group of M&G Investments fund managers outlines the president’s main successes and challenges since he stepped into the White House, as well as what they believe lies ahead for investors in US assets.
A seismic shift in American politics
Randeep Somel, manager of the M&G Climate Solutions Fund:
American politics has experienced a huge amount of change in recent months. The US has gone from Donald Trump, the first president to have had zero prior experience of US government, to Joe Biden; the complete opposite in terms of political background. Biden has been a senator since 1972, and he then became Vice President under Barack Obama. In other words, he knows exactly how Washington works and he’s the consummate dealmaker.
Biden has put forward a huge legislative agenda, which is rather ironic given that Trump used to refer to him as “Sleepy Joe”. His progressive agenda is anything but sleepy. He is driving probably the largest expansion of US government since President Lyndon Johnson’s 1965 Great Society programme. So, where are we likely to see change going forward, and what are the potential implications and pitfalls for global investors?
As a result of the pandemic, over the last year the US has put forward a stimulus package reaching nearly US$5 trillion, which is the largest ever recorded. To put this into context, the package that Obama enacted back in 2008 after the Global Financial Crisis was just shy of $800 billion. The two packages that Biden has now put forward total $4 trillion – split between his infrastructure plan and his Families Plan. There isn’t a part of American life that won’t be touched by one of these packages. It’s going to have an effect on how the US government spends money, how it taxes, the country’s debt level and the inflation rate within the US.
Q: What can we expect to see from Biden on climate action?
One of the biggest differences between Trump and Biden is their attitudes towards carbon emissions and the Paris Climate Deal. If you cast your mind back to Kyoto Protocol – you may remember that it failed for two very big reasons: the fact that both the US and China didn’t participate. Without the world’s two largest polluters – the protocol was kicked well into the long grass. For a while, it seemed as if the Paris agreement might be headed the same way. However, in recent months there have been two key developments: Biden has reversed Trump’s decision to withdraw from the agreement, and China’s President Xi Jinping has set binding targets when it comes to net zero – aiming to achieve carbon neutrality by 2060.
Interestingly, Biden has said that he intends to tie US financial aid and trade packages to countries that have set climate targets, so countries that are not within the Paris accord are likely to eventually find themselves in it, given that the three biggest economic areas Europe, China and the US now have binding targets, or are moving in that direction. This sets us up for fantastic tailwinds when it comes to climate-related companies. It increases risks around companies that are high polluters or unwilling to do anything about it, but in areas like green technology, clean energy and the circular economy we do see very strong and rapid growth ahead, which will be supported by what is a strong regulatory tailwind on a global basis. At the government, industrial and consumer levels, these targets are being taken seriously and in all facets of our lives now we are starting to see change. One area of concern, however, is post-pandemic government indebtedness, potentially impacting the ability to effect change going forward.
Q: Will Biden manage to enact all the legislation in his expansive agenda?
It’s important to think about how the US government is set up. Yes, Joe Biden is president but he has to get legislation through both houses of the United States Congress. Both houses are currently democratic, but Biden has wafer thin majorities. The US Senate is 50/50, and Vice-President Kamala Harris is able to cast a deciding vote, should there be an equal split ‘for’ and ‘against’ for any legislation Biden proposes. Biden also has a very thin majority in the House of Representatives. He needs to keep his whole party on side to get legislation through and, given that Biden’s agenda is so expansive, it will take time to legislate. The next set of mid-term elections in the US take place in November 2022, so Biden has a window of approximately 18 months to enact this legislation. Based on what we’ve seen before, the ruling party tends to not do very well in the first set of midterms, and with only wafer thin majorities, I wouldn’t be placing any money on the assumptions that it’s likely Biden will keep both chambers come January 2023. That’s why it will be crucial for him to move forward quickly with his incredibly ambitious agenda.
Historically, Biden always starts off from an extreme position – knowing he needs to give the other side ground to make up in order to get things through. This will include members of his own party that are not on the liberal wing. One example is Senator John Manchin of West Virginia, who is a very conservative democrat. This one senator could derail Biden’s entire agenda. The one thing that Biden has going on his side is the fact that the Republicans are in disarray, and can effectively be split into the ‘pro-Trump’ and ‘against Trump’ camps. This offers Biden a window of opportunity.
The outlook on inflation
Q: While fiscal and monetary policy have mainly gone hand in hand over the last 13 years, are we likely to see this diverge? And what would the implications be if that is the case?
Eva Sun-Wai, manager of the M&G Global Government Bond Fund:
Markets continue to price in much more hawkish interest rate scenarios than the Fed’s dovish message would suggest, albeit with little imminent risk of hikes: for example, bond markets generally seemed fairly unruffled by US Treasury Secretary Janet Yellen’s recent comments about interest rate rises potentially having to rise to prevent the economy from ‘overheating’. Some normalisation of monetary and fiscal policy is unavoidable, but central banks are generally reminding us that tapering is off the table for now and that the removal of supportive financial conditions will be done in baby steps. The main thing that the Federal Reserve will want to avoid is market volatility. The reflation trend should continue to be supportive of riskier assets and drive nominal curves steeper, which we are positioned for in our funds.
Improving fundamentals and underlying economic data prints also encourage us to keep hold of those ‘linker’ positions for now, as the Fed has repeated that it would continue buying Treasuries and mortgage-backed securities until substantial improvements have been made towards the committee’s employment and price stability goals. What markets need to be careful about is not to assume that one good employment report or one positive inflation print will automatically lead to a massive tapering scenario. The June FOMC meeting will likely be crucial in this sense as, by then, the reopening of the economy should generate some significant data improvements and the Fed can start to look at potential start dates to reduce those asset purchases. Vaccinations and pandemic-related developments will, of course, affect this timeline. In terms of fiscal support, vaccinations and the reopening of economies will be key as these will determine when we can get that smooth transition between stimulus cheques being spent and then savings being redeployed in the services sector. It’s important to consider the amount of scarring that might be left behind, where fiscal stimulus will likely need to be redirected to those industries that aren’t able to recover as smoothly. People who are currently relying on fiscal support such as furlough payments may suddenly find themselves unemployed and unable to retrain into different industries.
Q: History shows that US government spending doesn’t usually keep up with government tax receipts. With such a large national debt post pandemic, what is the level of concern around holding US Treasuries and the US dollar, given the president’s plans?
When it comes to holding US Treasuries and the US dollar, some caution is needed. The dramatic revision of US growth prospects when Biden first announced his initial plan took bond yields and the dollar higher in Q1. However, April saw US growth expectations reach more of an equilibrium and Treasuries seem to have settled into a bit of a range, but edging higher based on continued fiscal packages and strong data (for example, in response to US ISM prints).
With policy on hold and no dramatic shake-ups to the overall recovery story, I see prospects for yields to gradually rise on robust Q2 data, also supported by strong vaccination rates and higher realised inflation. Positioning also feels a bit cleaner on the Treasury curve, unlike in early April when bond yields declined and short covering really exacerbated that rally. With earnings season behind us and corporate issuance slowing down, the main thing markets seem to be waiting for is that data – which could be interesting following the recent infrastructure plan announcements and the follow through that that has on data releases. It’s currently very difficult to tell how much of that economic recovery and future progression is being priced in. In terms of positioning, we retain positions in steepeners, whereby the frontend will likely stay a bit more contained as markets are pricing in hikes to start in early 2023, but the committee expects policy rates to remain at zero in 2023. Ahead of that, the short part of the curve should remain fairly anchored.
With regard to the US dollar, rate volatility remains high which tends to be dollar positive. A very strong relationship historically that we look at a lot has been the dollar versus Treasury and Bund rate differentials. So a key factor for the dollar will not just be the US but also how the rest of the world performs as well – in particular Europe and how it catches up with America. So far, European growth expectations have been lagging and the vaccination story has been a lot slower. However, euro-dollar crosses could make further gains in May and June if Europe delivers progress on vaccines and sentiment generally improves towards the European economy. This would drive Bund yields higher and cause that Treasury and Bund spread to narrow. Ultimately, we are probably cautious on the Treasury curve going forward with a preference for steepeners, and the with the dollar very euro and EM/FX dependent.
Positioning multi-asset portfolios
Q: Are corporate tax increases priced into US equity valuations? And where are you finding better value at the moment?
Maria Municchi, manager of the M&G Sustainable Multi Asset Fund:
There are definitely some very important implications from a macro perspective that we need to factor in. Taxation is an important area, together with Biden’s overall spending plan. It’s difficult to determine a clear relationship between taxation levels and GDP growth, and there isn’t really a linear relationship between those two things over the medium term. However, the impact that higher taxation will have on the corporate sector will be quite significant depending on what type of taxation levels we’ll eventually end up with. Even if growth itself might not be specifically affected by taxation levels – especially given the type of targets we’re looking at in terms of corporate sector and high earners – there’s definitely going to be some potential repercussions on equity markets which would be driven partly by earnings being affected by taxation, but also by where valuations are today.
There is currently a real conundrum in the equity valuation space when looking at markets and how to start factoring in some of these key Biden administration policies. We start from a point where valuations overall, especially in the US, are relatively expensive. We are seeing a market that is pricing in quite a lot of this growth and recovery on earnings, so there are potentially some challenges on where valuations are today, but there is also a lot of differential in terms of geography and sectors. There are different pockets of rich valuations, versus less rich and more attractive valuations both in the US but also more broadly from a geographic standpoint.
Sector and geographical diversification are interesting aspects in terms of multi-asset investment. The fundamentals are quite different – the US is reaching a much more advanced level of growth and recovery compared to Europe. Also the spending plans in the US are significantly bigger than in Europe, for example. Looking at valuations alone, Europe might offer some better opportunities, should we see a reopening of economies in the coming months. Having said that, we are also looking at valuations in a condition of very low cash rates, which can distort valuations. This means that, while there are some areas that appear relatively attractive, they can look expensive when taking low cash rates into account. Future levels of interest rates could also have a huge impact on everything that is linked to equity markets. Then there is the question of whether we will see short-term inflation or inflation that is more structural and long-term in nature.
We are currently favouring equities over bonds – both from a valuation standpoint as well as from a macro-economic point of view. It’s important to seek diversification to protect against any leftfield events. Diversification from a multi-asset perspective means that while investors may still be invested in assets such as US Treasuries that may not provide extremely attractive opportunities for returns, these assets can offer some diversification protection in cases where there are unexpected events that could damage growth.
Q: What is the impact of US social policy initiatives, such as education and childcare support, on investment?
A large proportion of Biden’s spending plan relates to social policy. The focus of the spending package has really highlighted the importance of social inclusion in Biden’s agenda, and there are different sectors that are especially poised to benefit from this, including those that are linked to some of the United Nations’ Sustainable Development Goals, such as SDG4 (Quality Education) SDG3 (Good Health and Wellbeing) and SDG10 (Reduced Inequalities). There is plenty of interaction between potential opportunities for investors from a financial perspective, as well as opportunities to effect positive social change. This is particularly important given the post-pandemic scarring that is affecting minority parts of US society most.
Another interesting aspect that Biden has mentioned is using foreign policy as a tool to bring the US back into the international scene and economy. Education spending is very much a part of that. Investing in children and families is a good way of helping US society bounce back so that it is able to compete on an international level with other very strong economies.
Finally, Biden has put job creation at the centre of his plan, and it’s interesting to see how both fiscal policy and monetary policy are working in unison to try to deliver that. This is something that has been mentioned not only during Biden’s addresses but also more recently by the Fed’s chair Jerome Powell. When Powell spoke about unemployment levels from a Fed perspective, he focused on people in the margins of society, such as those coming out of prison and their difficulties in finding work. This approach to unemployment is shared by both the fiscal and monetary efforts of the administration and it will be interesting to see what this leads to – not only in terms of the unemployment number, which was already relatively low before the pandemic, but also with regard to wage growth and what that means for society at large.
Building better infrastructure: Biden’s own ‘Sputnik moment’
Q: The US is the wealthiest country in the world, yet it is still behind many other countries when it comes to infrastructure. Biden has put together a large infrastructure package, but he isn’t the first president to have attempted this. In fact, his predecessor also had an infrastructure plan, though it didn’t lead to much. So, what – if anything – has changed?
Alex Araujo, manager of the M&G Global Listed Infrastructure Fund:
Like President Dwight Eisenhower’s creation of NASA and the Space Race, Joe Biden has had his own ‘Sputnik moment’. Back in the 1950s, Eisenhower was faced with the dual crisis of the post-WWII period and the Cold War. Similarly, Biden has his own crisis to deal with in the form of the pandemic. Eisenhower kickstarted the Space Race after the launch of the Russian Sputnik satellite raised concerns among Americans over the need to catch up to its ideological and economic rival. In similar fashion, Biden has realised that the US is falling behind to a very different competitor in terms of infrastructure – and that competitor is China.
During the Pittsburgh speech that unveiled the new US infrastructure plan, Biden not only referred to Eisenhower, the Space Race and Eisenhower’s monumental infrastructure achievement – the US Interstate Highway System – but he also mentioned China numerous times – stressing that the country is “eating our lunch” and the need to “win the global competition with China”.
Infrastructure in the US is indeed in great need of repair, improvement and innovation. A lack of infrastructure is not just about inconvenience, it’s an issue of public safety – to prevent or fix major hazards such as collapsed bridges and motorway sinkholes. Building new infrastructure also creates jobs. Much of Biden’s infrastructure package is focused on traditional roads, bridges and the provision of clean drinking water – the things that are critical to society, human safety and a functioning economy.
Trump’s approach was to remove the red tape and soften the environmental standards and permitting requirements around infrastructure, but nothing really happened. Trump was unwilling to subsidise what he saw as democratic states and make actual fiscal overtures to those jurisdictions. Infrastructure typically comes under the jurisdiction of the state rather than federal government. But, under Biden, there is now a broad, national, coordinated plan and a president that in all likelihood could make it happen by getting his initiatives or some form of the package through Congress.
Q: Which sectors and assets are you focusing on in particular?
We take quite a broad approach to the infrastructure asset class. We extend the typical definition of infrastructure to include modern infrastructure assets, such as those that facilitate digital connectivity. Digital infrastructure is part of Biden’s plan – with the need for physical points of presence such as towers, data centres and broadband connectivity. We also invest in social infrastructure, which is another very important component of his plan. The world has come to realise that healthcare infrastructure, for instance, really needs to improve practically everywhere to accommodate the kind of crisis that we are going through.
The other key part of Biden’s plan focuses on climate change. The utilities sector is the single biggest sector of exposure within our strategy. The sector suffers from a bit of an identity crisis, because it is still globally the single biggest offender in terms of greenhouse gases and emissions. However, at the same time, utility sector companies are at the centre of the solution because they are the companies that are deploying renewable energy assets and making the transition to more sustainable forms of electricity generation. So, clean energy, renewable energy and transition-oriented businesses are a unique focus for us as well.