The Covid-19 pandemic has been a human tragedy on a grand scale.

It has also been the most sudden, wide-ranging and dramatic economic crisis for generations.

In response, the Biden administration has proposed enormous spending plans aiming to both sustain the recovery and radically increase the size of the American state.

Are Joe Biden’s economic policies the end of forty years of post-Reagan orthodoxy? And what could they mean for investors’ long-term strategies?

Jack Janasiewicz, CFA®, Senior Vice President, Portfolio Strategist and Portfolio Manager at Natixis Advisors, breaks down where Bidenomics might take the US economy.

Jack Janasiewicz, CFA®

Senior Vice President, Portfolio Strategist and Portfolio Manager
Natixis Advisors
For a very long time, inflation was the priority: Now we’re seeing price stability placed as secondary to employment, which is a change in emphasis with enormous real-world consequences.

The world has obviously changed fast over the past year. Are we entering a new era in how the US government intervenes in markets?

For me, the big hinge point has been the realization that monetary policy can only do so much. For some years now, we’ve been relying on the Fed to stimulate growth, whether through quantitative easing or cutting rates. The problem has always been that multiplier effects get dampened when you put all this money out there and nobody gets to spend it, and recent events have magnified this. So, on those terms, the Biden administration’s pivot to spending on such a grand scale feels consequential.

It’s also part of a long-term trend: Rates have trended downward for so long that we’ve become a much more leveraged economy than we were 15 years ago. This reduces the incremental benefits of cutting rates, so again the multiplier effect gets dampened down. There had to be a switch at some point, and we’re seeing it now. For a very long time, inflation was the priority: Now we’re seeing price stability placed as a secondary priority to employment, which is a change in emphasis with enormous real-world consequences.

However, it remains to be seen how permanent this is. Covid was obviously an emergency, but as we hopefully move on and the general picture reverts to something like normality, it’s an open question how comfortable lawmakers will be with this level of fiscal aggression.

Some commentators have gone as far as to say Biden’s policies represent a decisive break with the economic orthodoxies of the past forty years. Is that fair?

I get why people like those hyperbolic headlines – they do resonate. But if you look back to part of the package Trump campaigned on in 2016, he talked a lot about infrastructure, so this has been in the air for a while.

Also, I don’t want to get too into things like social unrest, but one of the biggest challenges facing the US is the gap between the haves and the have-nots, and that has been without a doubt a factor in the turbulence we’ve seen in recent years. I don’t think there’s going to be a revolution any time soon, but with Covid we’ve seen what happens when a huge risk that usually belongs in science fiction films actually comes true. There’s no doubt that changes how people think.

So you have this mixed picture, where Covid has opened up what’s possible, but we also have a mentality where policymakers are now taking seriously the risks that were once thought unthinkable. It comes down to either not addressing the widening wealth gap and risking social instability in the future, or Biden creating the more inclusive economy he talks about. We can argue about this or that policy, but I certainly think it’s better if this works.

Inflation is often raised as a potential outcome of Biden’s policies. Would you agree?

When economists talk about inflation, they’re usually talking about the seventies, and it’s important to keep in mind that today we face a totally different structural picture to back then. Whether it’s the influence of organized labor or the impact of the 1973 oil crisis, the world is just so different in so many ways to that period that I don’t think it’s a useful comparison.

I think a lot of commentators don’t appreciate that inflation is a very difficult thing to generate. If we were looking to recreate the inflation picture of fifty years ago, we’d need money demand to pick up in aggregate. If you look at the credit metrics from the banks, we’re just not seeing it. Banks will happily lend, but the demand is pretty tepid.

In the short term, a lot of bottlenecks that have been resulting from supply chain disruption and so on can certainly result in commodity inflation, but that’s a supply and demand issue – not a structural threat.

What about if we look longer-term?

When you look long-term, you need to look at demographics. Right now, we’ve got the Millennial generation of people born in the eighties moving into the sweet spot of their high-earning years while the Baby Boomers are retiring and – being frank – ceasing to be productive members of their economy. It’s a numbers game: there are a lot of Boomers exiting the economy, so that’s a significant deflationary pressure we can assume for some time.

Also, as online retail matures in the US, you have an additional deflationary pressure. In that it aids price discovery – It makes price discovery incredibly easy, which is highly like to push prices down.
Then you’ve got the deglobalization argument. Chinese labor isn’t as cheap as it used to be, so if a significant amount of global manufacturing activity moved to, say, Mexico, that would keep margins fat.

These are the real structural factors, not the bumps along the way to the normalization of economic activity.

The conventional wisdom is that interest rates will remain very low for the foreseeable future. How does that shape the picture as we look forward?

I would again take it back to supply and demand. I think it’s very under-appreciated that there’s just not enough assets in the world. We can see this if we look at price-insensitive buyers like insurers and pension funds – their demand is growing all the time, especially at time when the Baby Boom generation is retiring in huge numbers, which is in turn driving demand for fixed income assets.

We should place this into the picture of the ongoing action by central banks, where they are taking bonds out of the system, pushing rates down and trying to incentivize people up the risk spectrum. It’s likely that the central banks are going to hold these bonds to maturity, keeping them off the secondary market and creating more demand for high-quality fixed income assets. This is leading these big bond buyers to turn to emerging markets, where the demographic picture is positive for long-term assets.

I think that while rates aren’t going to stay this low forever, these factors should keep a lid on them in any future we can credibly anticipate.

One impact of low interest rates has been to sustain asset prices at consistent record highs. This prompted talk of a bubble in early 2021, but that’s faded away somewhat now.

There’s no denying American equities have done pretty well – but just because something’s up a lot, it doesn’t mean it’s in a bubble.

Are there pockets of excess in the market? Without a doubt. Have markets been distorted somewhat by the huge amount of savings affluent households were able to make through 2020? Also true, to an extent. But are we talking about a bubble?

Well, look at it like this: If I’m a Millennial saving for retirement, I’m almost forced into equities thanks to low bond yields. As we’ve already talked about, you’ve got more money coming into the system chasing the same number of assets – or fewer, given there are still not as many listed equities in the US as there were in the late nineties. Supply and demand kicks in again: It’s Economics 101.

If we wanted signs of a bubble, I would look more to sentiment indicators – the proverbial cab driver who wants to talk about his stock portfolio. Otherwise, as long as we remain in the present interest rate environment, I think there’ll be ongoing confidence in American equities.

If we’re thinking about long-term strategies, where do we place foreign exchange risk in our thinking?

I think the easiest way to think about the dollar is the famous “dollar smile,” where at one extreme growth is so strong relative to the rest of the world that capital is drawn to the US, which in turn drives up the dollar.

At the other extreme, however, you have the Armageddon scenarios where the dollar acts as a safe haven as the world goes to hell in a handbasket. This increase in demand also drives up the dollar.
In between these extremes, you have an environment where growth is more homogenous around the world, and the good times mean higher risk appetites, which means more demand for emerging market equities. Covid compressed all three of these scenarios into a very short period of time.

What does this mean? It means that the value of the dollar as we move forward is going to be a product of the interaction between Biden’s expansionary policies and the global growth picture. There are a lot of uncertainties here, but if the market was expecting a big inflation kick in the US, you’d expect that to be priced into the rate backdrop, and we’re not seeing that.

With that in mind, I think it’s easiest to fall back on that dollar smile framework. It doesn’t get too complicated, and there’s a lot of truth in it. I certainly don’t think the paranoia in some quarters about deficit spending debasing the dollar is justified – we’ve heard that story for fifty years, and guess what? The dollar is still the global reserve currency, and it will continue to be for a very long time.

Covid has been the proverbial ‘black swan’, even if experts had warned a pandemic was all but inevitable at some point. What do you think are the main risks policymakers and investors aren’t taking seriously enough?

I think cryptocurrencies are definitely at or near the top of the list. They are often described as non-correlated assets, but at one point you could buy your Tesla with Bitcoin. They’re more interconnected with the wider market than many people think, and the size of the crypto market has become significant. We need to think more about and understand better the relationships between crypto and conventional assets.

To take that further, you can make a case for the crypto market as the new risk barometer.

Everybody in our industry looks at the spreads in high yield bonds as a risk indicator, with good reason, but the probability of contagion spreading from crypto to other markets is far from zero. If we look at all the policies enacted after the financial crisis of 2008, you can point to some success in preventing contagion – indeed, a banking crisis is pretty much the only thing that didn’t happen in 2020. That means you need to think about where the vulnerabilities are in the system that haven’t been anticipated or accounted for by policymakers.

I don’t think we’re in any serious risk of crypto causing a 2008-style disaster any time soon, but when you think about how far ahead the technology is of any real scrutiny of its risks, and combine that with the almost total lack of regulation in the space, it’s definitely something to think about.

Then, on a somewhat connected note, you have cybersecurity risk. The ransom that was paid after the Colonial Pipeline hack in May 2021 was paid in Bitcoin. I think it’s safe to say that ransomware attacks like these aren’t going anywhere any time soon. It’s likely that governments are going to crack down on this kind of thing, especially as these hackers appear to be getting greedy and drawing attention to themselves.

How successful these efforts will be remains to be seen, but there’s absolutely no doubt that there is a huge risk of a far bigger and more malicious attack, and it could come from people who aren’t interested in any ransom.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted, and actual results may vary.

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