Progress on US bipartisan infrastructure bill

US President Joe Biden has revived his ambitious infrastructure plans by announcing his endorsement of the Bipartisan Infrastructure Framework last Thursday, which is a compromise deal proposed by a group of 10 centrist senators comprising lawmakers across both Republican and Democratic parties.

Back in early June, uncertainties around President Biden’s ambitious American Jobs Plan had started to build when the White House announced that it ended negotiations with several Republican leaders, in part due to the corporate tax increases needed to finance President Biden’s proposal of ~USD1 trillion worth of new spending.

This latest Bipartisan Infrastructure Framework focuses on a narrower infrastructure package amounting to USD1.2 trillion in total spending, of which USD579 billion would be new spending above the current baseline. Notably, the White House made no mention of corporate tax increases, which could help the proposal gain traction among Republicans, and instead announced that this latest scaled down proposal would be funded by several sources including proceeds of the 5G spectrum auctions.

We believe Biden remains committed to see a deal as he is keen to bridge the gaps and revitalize bipartisanship on Capitol Hill - a key message of his presidency. The outlook for a positive fiscal impulse from infrastructure spending in the US remains positive albeit uncertainty over the details.

We believe that the passing of an infrastructure bill would catalyse key structural trends and investment opportunities in cyclical sectors and companies related to areas such as broadband, grid modernization, clean energy and storage, and electric and autonomous transportation, including beneficiaries of increased spending such as certain Machinery, Engineering & Construction, and Construction Materials companies.

The current situation, however, is not without complications. Democrats across the Senate and House appear determined to tie the latest infrastructure proposal with another bill to progress their agenda on education, healthcare and antipoverty efforts.

In our view, if bipartisan negotiations fail, Democrats will likely move ahead with a single, large reconciliation bill later this year, with the added complication in the background – raised by Secretary Yellen last week – that the Treasury could exhaust the room under its debt limit in August.

In any case, given the significantly drawn-out timeline for the infrastructure spending package, we will see a fiscal drag in 2022 versus 2020/21 – an environment of post peak stimulus and growth that the market will need to navigate ahead.

In this situation, we see the Fed maintaining an overall accommodative stance even as it eases out of current extraordinary measures in order to solidify the economic recovery and achieve its dual mandate of full employment and inflation.

Another recent key development in global markets was the June Federal Open Market Committee (FOMC) decision on 16 June and the publication of the Federal Reserve’s latest economic projections.

Market attention was squarely focused on the latest “dot plots” after the undeniable uptick in inflation since the last FOMC, as the US economy reopened, as well as any communique on its asset purchase program.

Updates to the Fed’s economic projections, in particular a higher inflation forecast for 2021, and the latest dot plots delivered a hawkish surprise to the markets. 13 of the FOMC’s 18 members now project the fed funds rate to start rising in 2023 compared to just 7 previously. 7 of the 18 policymakers now see the first Fed rate hike likely occurring as early as 2022 and the median projection for two 25bps increases in the fed funds rate – not just one – in 2023.

Furthermore, the Fed also acknowledged that it had began to discuss when to start tapering quantitative easing, and that “it will be appropriate to consider announcing a plan for reducing our asset purchases at a future meeting”.

As we had indicated earlier in our research, given where the Treasury yields were positioned, the degree of market reaction to a tapering message by the Fed over 2021/22 is unlikely to match the magnitude seen during the 2013 taper tantrum episode, in our view.

While the initial knee-jerk reactions to the Fed’s hawkish pivot were expectedly negative, the overall market reaction over the last two weeks has been relatively benign. Especially as the heavy Fed speak continued through last week, where senior voting members of the FOMC reiterated its dovish stance and that the US economy had not made ‘substantial further progress’ to justify the Fed shifting its stance.

Risk assets have since reversed most of the knee-jerk losses in the direct aftermath of the FOMC meeting and more, with the S&P500 touching new historical highs alongside strong performance in Asian and European markets over the past week.

Over the short term, the changes to the Fed’s stance have clearly shifted the rates market and resulted in a more mixed outlook for the US dollar. The Treasury curve has flattened and 2-year US Treasury yields are now at their highest levels since the pandemic started.

The US dollar (measured by the DXY) has appreciated close to 1%. This portends a greater scope for market volatility ahead, in our view, particularly for emerging markets assets for which periods of dollar strength have historically created headwinds.

Over the longer term, however, while the Fed’s hawkish pivot has been a result of divergent views within the committee (notably hawkish regional Fed presidents including Bullard and Kaplan) we believe that senior Fed leaders, including Powell, Williams, Clarida and Brainard (who vote at every FOMC meeting) remain primarily very dovish in their positions.

We expect that the Fed’s leadership will keep monetary policy ultra-accommodative - and taper its quantitative easing program most likely only early next year, particularly given the base case scenario that inflation pressures in 2021 will likely prove to be transitory.

Over the long term, this will continue to benefit risk assets and curb US dollar strength, and we remain moderately overweight in terms of our overall risk exposure in our asset allocation strategy through our overweight positions in US equities and Emerging Market High Yield bonds.

We also continue to favor higher yielding currencies like the CNY and currencies likely to be boosted by central banks hiking rates in 2022 including the GBP and CAD.