Markets Catch Stride in Build Up to Infrastructure Legislation

Gone, for now, are the days of dismal lows and ebullient highs as Wall Street awaits with less enthusiasm news of an infrastructure spending bill.

Seated clockwise, Vice President Kamala Harris, President Joe Biden and Transportation Secretary Pete Buttigieg meet with lawmakers, including the heads of the House Transportation and Infrastructure Committee, on March 4. (AP Photo/Andrew Harnik)

MANHATTAN (CN) — Now that the immediate boost from the stimulus package has worn off somewhat, trading on Wall Street may become less wild.

Wall Street rocketed to new heights and also saw massive drops since the $1.9 trillion stimulus package delivered $1,400 checks into the bank accounts of about 127 million Americans. With the stimulus out of the way, however, investors are staking out more stable ground and preparing for inflation to take hold, in one way or another.

Suffering a few hiccups during the week, by the closing bell on Friday, the Dow Jones Industrial Average gained 445 points since last week, but nearly all those gains came on Friday, with investors seeing a 1.4% increase. The S&P 500 gained only 61 points for the week, while the Nasdaq lost 77 points since last Friday.

Investors now have two primary questions driving their trades: Will the infrastructure spending proposal bandied about on Capitol Hill jack up taxes, and will 1970s-era inflation take hold without action soon by the Federal Reserve?

The $3 trillion infrastructure bill, which is expected to be formally announced next week, would have less immediate economic impact than the $1.9 trillion stimulus package, experts say, but its longer-term effects are not yet quantified.

“With few shovel-ready projects, spending on an infrastructure package would be spread over a decade,” wrote Michael Pearce, a senior U.S. economist at Capital Economics. “With the package also set to be at least partly offset by higher taxes, the near-term stimulus would be small. Higher corporate taxes in particular would mean the bill could be positive for the economy, but negative for the stock market.”

Planned infrastructure and child care spending meanwhile could fix “persistent problems on the supply side,” he wrote, and it could also help female labor force participation — lower in the United States than in many other developed economies.

Others say the effects of the last stimulus are yet to be fully baked into the economy. “It is the April and May numbers that are going to show the big increases as price levels in a vibrant reopened, supply-constrained economy contrast starkly with those of the one in lockdown last year,” wrote James Knightley, chief international economist at ING.  

He noted that this will force the Federal Reserve’s hand on raising interest rates. “The Fed will continue to push their very dovish view for the next few months, but we suspect that will be increasingly difficult to reconcile with the data flow we expect to see through 2021,” Knightley wrote.

So far, though, the Fed has shown no sign of budging.

During testimony before Congress on Wednesday, Chair Jerome Powell praised recent stimulus legislation, stating that while the economy has suffered “the worst was avoided by swift and vigorous action” from lawmakers.

Powell has been on a public relations campaign, in a sense, for the central bank. In an interview with NPR on Thursday, he said that the Fed’s response to the economic fallout from the pandemic was similar to the emergency response of Allied forces in World War II to the bombing of Dunkirk.

“It was the time to get in the boats and get the people, not to check the inspection records and things like that,” Powell said. “Just get in the boats and go.”

Other Fed officials have tried to mollify investors, who have grown increasingly worried about inflation.

Vice Chair Richard Clarida once again said that while inflation would peak later this year, it would likely go back to the 2% goal in 2022 and 2023.

Disagreeing with former Treasury Secretary Larry Summers, who criticized the recent $1.9 trillion stimulus package, Clarida said, “I don’t think so,” when asked at an Institute of International Finance webcast if the recent fiscal support would create a long-term, persistent upward risk of inflation.

In his speech, Clarida added that, “going forward, a low unemployment rate, in and of itself, will not be sufficient to trigger a tightening of monetary policy absent any evidence from other indicators that inflation is at risk of moving above mandate-consistent levels.”

Lael Brainard, a member of the Board of Governors, also stated that “current employment and inflation outcomes remain far from our goals,” solidifying the promise the Fed would keep interest rates low for some time.

Some are still extremely critical of the Fed’s approach to interest rates. “The Fed speakers that tell you they won’t raise rates until their ‘employment goals are met’ are the very same Fed speakers that cut rates 3 times in 2019 when unemployment was at a 50-year low of 3.5%,” tweeted Sven Henrich, founder of Northman Trader.  

Knightley also sees inflation rising later in the spring “as price levels in a vibrant reopened, supply-constrained economy contrast starkly with those of one in lockdown last year.” It will be difficult for the Fed to remain dovish on interest rates much past 2021, in Knightley’s view.

Others, such as David Mericle and Laura Nicolae of Goldman Sachs, see some parallels between today’s economy and the overheated U.S. economies of the 1960s and 1970s, when fiscal policy was expansionary, but note a repeat of those days is unlikely.

“First, the era of successful inflation targeting has better anchored inflation expectations on the Fed’s target, making inflation less persistent as a result,” the researchers said in a Friday investor’s note. “Second, having learned from past mistakes, Fed officials see keeping inflation expectations anchored as a paramount goal and monitor them actively with a wide range of measures.”

The specter of inflation is certainly the dominant one haunting markets right now, but it could also be a boogeyman that remains huddled in the closet, according to an analysis compiled by the St. Louis Federal Reserve. That analysis shows that in the last several years expected inflation has almost always exceeded actual inflation, sometimes by a quite a bit.

A 2018 paper cited by the Fed found that perceived inflation is usually informed by past inflation. “Individuals who perceive higher inflation in the past tend to expect higher inflation in the future,” the researchers wrote, “[and] people whose perceptions change tend to revise their expectations in the same direction.”

Other concerns have abated somewhat. While overall unemployment is still high, new unemployment claims are at the lowest weekly rate since before the pandemic began last year, according to the Labor Department.

About 684,000 new claims were filed for the week ending March 20, according to the agency, compared with 770,000 initial claims the week before. At the height of the pandemic, more than 6 million claims were filed in a single week.

The number of cases of Covid-19 continue to come in as Americans let down their guard waiting to be vaccinated, but fortunately the number of intensive care unit beds occupied by Covid-positive patients also has decreased from the high point in January.

As of March 12, only 9,300 ICU beds were occupied by coronavirus patients compared with 46,000 beds occupied by other patients, according to data by Johns Hopkins University. The United States has about 30 million cases of Covid-19 and 547,000 deaths, according to the data, compared with 125 million cases and 2.7 million deaths worldwide.

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