Sunday, September 24, 2023

How Joe Biden’s stimulus package rocked global financial markets

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The “blue wave” struck later than expected, but with enough force to force a reorganization of global financial markets.

The second-round victories of the U.S. Senate in Georgia on Jan.5, which saw the Democratic Party take control of Congress to add to the presidency, prompted investors to reform their portfolios in anticipation of the stronger fiscal stimulus promised by the government. US president-elect. Joe Biden – who detailed his $ 1.9 billion package Thursday.

The effects have been significant: technology stocks have struggled, while the prices of raw materials used in infrastructure projects, such as copperand the shares of machine makers like John Deere and Caterpillar grew. Global crude oil prices topped $ 55 a barrel for the first time since the pandemic rocked markets. And the lower rated US state and local debt rallied on the promise of additional federal support.

But perhaps the most significant impact can be found in the government bond markets which form the basis of the prices of other assets around the world. Analysts now expect more debt issuance and higher inflation, putting pressure on the Federal Reserve to end his bond buying program and maybe even raise interest rates sooner than expected. Ten- and 30-year government bond prices have fallen since the start of the year, pushing yields to around their highest level in nearly 10 months.

“Many assets are built on the prospect of extremely low interest rates for the foreseeable future,” said Mike Stritch, chief investment officer at BMO Wealth Management. “In terms of financial risks, we think it’s one of the biggest.”

The promise of additional expenses – which follows a $ 900 billion expense bill passed by Congress last month – “paved the way for higher inflation,” Morgan Stanley economists said earlier this month.

The 10-year “break-even” rate, a measure of market expectations for price increases that is derived from the price of inflation-protected government bonds, has climbed above 2 percent . This is less than 0.5% at the height of the crisis last year.

Meanwhile, the leader board for US stocks has changed. Long-favored tech stocks including Apple, Microsoft and Salesforce have lagged the market since the Jan.5 runoff. As of Friday’s close on Wall Street, technology stocks in the Russell 3000 Index were down slightly for the year, trailing behind. a gain of 4 percent for basic materials groups, an increase of almost 5 percent for financials and an advance of about 14 percent for energy companies.

The tech sector has outperformed since the financial crisis, amid lackluster global economic activity – a trend that was exacerbated during the pandemic. Lower interest rates increased the appeal of companies whose valuations depended on profits in the distant future, while lagging behind sectors like banking.

Daily price line chart, rebased,% change showing small cap stocks rose with the 'blue wave' as technology slows

A rotation of technology to economically sensitive sectors such as small caps and unloved “value” stocks, including financials, began to take hold last year as prospects for a “blue wave” »Were developing US elections. But the Democrats’ initial failure to secure a Senate majority in November left many investors instead positioning themselves for a stalemate in Washington.

The Georgia run-offs revived this trade. The results were “the straw that broke the camel’s back,” said Bob Doll, a senior portfolio manager with asset manager Nuveen. “After years of wanting to brag about how many great growth stocks you own. . . you are now at the point where you need to have small, value and international stocks in your portfolio. ”

Consumers and businesses are likely to remain dependent on tech companies that filled in the gaps during the crisis, but the rollout of the coronavirus vaccination and additional government spending are expected to lift sectors hardest hit by the pandemic.

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In anticipation of an economic recovery that is seeping into the heart of the United States, investors have invested around $ 27 billion in small-cap equity funds since the start of November, making more than ” cancel all of the cash outflows that the funds had booked during the first 10 months of the year. Small businesses are expected to thrive as Americans chart a path to normal life. Emerging market exporters are also expected to benefit from the recovery in demand.

Demand for rising price hedges was also strong, with US funds that buy inflation-linked Treasury securities, or Tips, attracting nearly $ 1.5 billion in net inflows during the week. ending Wednesday, according to EPFR data. This marked the 15th week in a row that more money entered these funds than it left.

Column chart of weekly flows to inflation-protected U.S. Treasury funds (in billions of dollars) showing that investors are seeking inflation hedges

The question now is how much fuel Democrats will add to the world’s largest economy, at a time when monetary policy remains ultra-loose.

“The world economy and American economy are experiencing an early cycle dynamic characterized by rising growth, rising corporate profits, rising prices, ”said Erik Knutzen, Neuberger Berman’s investment director for the multi-asset strategy.

“But [that is] still in a very accommodating monetary policy environment and. . . with quite a bit of fiscal stimulus. “


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