Michael Zezas: Washington’s Trio of Tricky Travails

Oct 6, 2021

Negotiations in D.C. are heating up around fiscal policy, with potential impacts on the stock market and bond yields. The debate is whether to adopt a small or big approach to the bipartisan infrastructure framework. A small plan might stabilize bond yields, while a bigger agenda could push them higher. The urgency surrounding the debt ceiling adds another layer of complexity as Democrats seek to balance their goals with various party factions, extending negotiations and shifting timelines.

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INSIGHT

Fiscal Policy Impact on Bond Yields

Democrats are likely pursuing a larger fiscal package, including the bipartisan infrastructure framework and social safety net expansion.
This approach could increase bond yields due to boosted deficits and medium-term growth expectations.

INSIGHT

Debt Ceiling Debate and Market Volatility

The debt ceiling debate adds uncertainty to the market, as neither party seems inclined to a timely resolution.
This uncertainty contributes to potential stock price volatility in the near term.

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Discussions in D.C. over the infrastructure framework, budget reconciliation bill and debt ceiling could impact more than just politics. What could it mean for stocks and bond yields?

----- Transcript -----

Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between US public policy and financial markets. It's Wednesday, October 6th at 10:30 a.m. in New York.

When we checked in last week, the debate was all about fiscal policy. Would Democrats go small and just focus on passing the bipartisan infrastructure framework, or BIF? Or go big, linking the BIF to the bigger plan to expand the social safety net, environmental spending and the tax base. The difference matters, as a small approach could halt the increase in bond yields we've seen in recent weeks, whereas a big approach could keep them moving higher.

In short, it looks like the Democrats are at least going to continue to try and go big, as was our expectation. No votes were taken last week as it became obvious that there wasn't enough support for the small approach, which wouldn't fly with a bloc of progressives in the Democratic party. So, despite moderates' demands for a BIF vote by week's end, Democrats were forced to extend negotiations with a new soft deadline for action of October 31st. That reinforced to us the link between both pieces of legislation. So, in our view, we're still headed toward a multitrillion dollar package being enacted in the fourth quarter, which should boost deficits, medium term growth expectations, and therefore bond yields along with it.

But in the meantime, the rise in bond yields could take a break as Washington, D.C. deals with the debt ceiling. The Treasury Department says the ceiling must be raised or suspended by October 18th, less than two weeks from today, or else the U.S. could face default and an economic crisis. Republicans and Democrats continue to be at odds over how to avoid this. Without getting into the weeds on this too much, just know that at this point, neither party is showing an inclination to resolving this in a timely manner. That could create substantial uncertainty and it's one of the reasons that our U.S. equity team continues to expect stock prices could remain volatile in the near term.

So stay tuned - DC's influence on markets is sure to be felt through the end of the year.

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