Dear Friends,
On Thursday, March 11, 2021, President Biden signed the American Rescue Plan Act of 2021 (“ARP”) into law. This $1.9 Trillion emergency relief package includes payments to individuals and funding for federal programs, vaccines and testing, state and local governments, and schools. It is intended to assist individuals and businesses during the ongoing Coronavirus pandemic and accompanying economic crisis. For more information on the ARP, please click here.
The Economist states that the $1.9T stimulus plan is a high-stakes gamble for America. That is because America is running an unpredictable three-pronged economic experiment that features historic levels of fiscal stimulus, a more tolerant attitude at the Fed towards temporary overshoots in inflation, and huge pent-up savings which no one knows if consumers will hoard or spend. According to the Economist, this experiment has no parallel since the Second World War. The danger for America and the World is that the economy overheats.
The Fed is adamant that it will keep interest rates low and continue to buy assets until the economy is much healthier. Inflation will inevitably rise, but the Fed will ignore this. Under its new “average inflation targeting” regime, adopted last year, it is seeking to bring inflation over its 2% target in order to make up for past shortfalls. That is particularly desirable because, for much of the past decade, the world economy’s problem has been too little inflation, not too much. Even if the economy eventually overheats, Jerome Powell, the Fed’s Chairman, has argued that this, too, will be temporary. Longer-term inflation dynamics, he argues, “don’t change on a dime.”
Might they, however, turn on trillions of dollars asks The Economist? We have no reason to doubt the Fed’s near-term plans, but neither it nor the markets can predict the eventual outcome of America’s experiment. The Fed might have to pour cold water on the economy, raising interest rates to get inflation down. That would be awkward, given how much it has recently emphasized its obligation to seek “broad-based and inclusive” strength in the jobs market. Higher rates would puncture asset markets and might also precipitate conflict with an increasingly indebted government. Another piece of this puzzle is that marginal tax rates are at historic lows. President Biden’s proposed tax plan could lead to major changes to existing federal tax rules applicable to many individuals and businesses. Click here to view information about Biden’s Tax Proposal.
According to the Economist, Mr. Biden’s stimulus is a big gamble. If it pays off, America will avoid the miserable low-inflation, low-rate trap in which Japan and Europe look stuck. Other central banks may copy the Fed’s new target. Massive fiscal stimulus may become the normal response to recessions. The risk, however, is that America is left with rising debts, an inflation problem, and a central bank facing a test of its credibility.
We are watching these events closely, as we are very concerned about rising debt. In the meantime, we are focused on a “reflation” trade. We intend to take advantage of our current low-interest-rate environment, but we will remain vigilant in watching for signs of a change that will require us to alter our thesis and adjust portfolios
If you have any questions, please feel free to reach out to me.