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Rescue Act: Four Key Questions

I. How much of the $1.9 trillion is spent in fiscal year 2021?

· 03/16/2021 09:24

I. How much of the $1.9 trillion is spent in fiscal year 2021?

Approximately $1.2 trillion of the $1.9 trillion package, or 63% of the expenditures, will come in fiscal year 2021, ending September 30, as estimated by the non-partisan U.S. Congressional Budget Office (CBO), which is charged with putting a price tag on all Congressional legislation. In fiscal year 2022, another $400 billion will be spent.

The fiscal economic rescue package has many different types of spending programs, and not all proceed at the same pace. Over 90% of the direct payments to individuals ($415 billion) and the increases in unemployment benefits ($242 billion) will hit the US economy in the March-September 2021 period. Also, the business support programs for restaurants ($15 billion), airlines ($25 billion), and various other business support activities ($25 billion) will also arrive in fiscal year 2021. Grants to state and local governments ($350 billion) will occur 100% in the 2021 fiscal year.

Other programs are spread over longer time periods. For example, the small business programs ($9 billion) occur over a ten-year period. Likewise, such programs as pension assistance ($16 billion), child-care for workers ($6 billion), education, arts, and humanities ($170 billion), are not front-loaded, but extend over the ten-year period. See the appendix for a more detailed analysis of the size and pace of expenditures for the whole American Rescue Plan Act of 2021.

Figure 1: U.S.$ Expenditures by Fiscal Year

Figure 1: U.S.$ Expenditures by Fiscal Year

Figure 2: Percent of Total Spending by Fiscal Year

Figure 2: Percent of Total Spending by Fiscal Year

II. How will the $1.2 trillion of additional spending in fiscal year 2021 impact U.S. real GDP and employment?

In fiscal year 2021, the overall support for individuals will cause a sharp increase in Q2/2021 real GDP over what might have occurred in the absence of the stimulus legislation. This includes $640 billion from direct payments, as well as unemployment insurance increases such as additional funds for the Supplemental Nutrition Assistance Program, or food stamps. . Not all of the $640 billion will be spent, as some will be saved. Since the programs are heavily tilted toward moderate to low income individuals and the unemployed, though, the proportion that gets spent quickly is likely to be extremely high. The rest of the fiscal year 2021 expenditures of roughly $560 billion, will have a much more muted, albeit positive, impact on real GDP. This is because much of this money will either be used by states and local governments to cover previously incurred pandemic spending from 2020, or by businesses to be saved or put to work paying debts or past due rents, etc. Still, the overall impact on 2021 real GDP is considerable.

In this first quarter of 2021, the U.S. was already on track for an annualized rate of growth of close to 10%. Now, with the stimulus package, Q2 is likely to be well over 10% annualized growth. Indeed, calendar year 2021 might record overall 10% real GDP growth.

Unfortunately, the employment picture is not quite as buoyant. The spread of the virus and the pace of vaccinations are still the primary determinants of when the U.S. economy can fully reopen. Even when the pandemic is under control, some of the shifts in consumer behavior will continue. Many office workers will continue to work from home, or in some cases adopt more flexible work arrangements that will limit their needs to commute into downtown business districts. Corporations are expected to strictly limit business travel, perhaps, to about half of pre-pandemic spending. That is, restaurants, hotels, shops, in downtown business districts will come back much more slowly than other sectors. Transit systems will remain under stress from low passenger traffic compared to pre-pandemic levels. To be sure, there is tremendous pent-up demand for dining out, events, tourism, etc., which will allow these service sector jobs to return at a good clip, although probably not reaching pre-pandemic levels until well into 2022.

III. How will the $1.2 trillion of additional spending in fiscal year 2021 be financed?

The U.S. Treasury was already going to have a massive budget deficit to finance in fiscal year 2021 and beyond, and the American Rescue Plan Act of 2021 adds $1.2 billion to the fiscal 2021 financing needs. This means the U.S. Treasury will have to increase the size of its debt auctions by up to a trillion dollars, maybe a little less, in the March-September 2021 period. If we work with round numbers and say, hypothetically, an additional trillion dollars will be financed with marketable Treasury debt securities, then based on recent funding patterns which have emphasized longer-term debt, there might be an additional $200-plus billion of 10-year, 20-year, and 30-year debt issuance before the end of the fiscal year in September 2021.

Figure 3: Hypothetical Additional Treasury Debt Issuance

Figure 3: Hypothetical Additional Treasury Debt Issuance

For its part, the U.S. Federal Reserve (Fed) has provided forward guidance that even as the economy recovers it plans to continue buying $80 billion a month in Treasury notes and bonds in the secondary market, or $480 billion in the April-September 2021 period, which would be the equivalent of nearly half of the additional new financing required by the stimulus legislation. The Fed also is continuing its plans to buy $40 billion a month of mortgage-backed securities, with both buying programs extending through 2022 and possibly longer.

IV. How have interest rates and Treasury yields reacted in 2021 so far?

Market participants anticipate future events as best they can with a discount for risk and uncertainty. By February 2021, market participants had much more clarity on many items than compared to October 2020. For example, by February 2021, it was known that the Presidency, Senate, and House of Representatives would be under Democratic Party control, so the probability of a massive fiscal stimulus package was rising sharply even before the legislation was passed by the House and the Senate. Also, the pace of vaccine distribution was still an unknown back in October 2020, whereas by February 2021 there was much more confidence in vaccine distribution in the first half of 2021 accompanied by much improved optimism about the economic rebound.

Thus, even before the passage of the fiscal stimulus legislation, yields on longer-term notes and bonds had started to rise (i.e., prices falling). We would argue that much of the anticipation of improved economic growth, a whiff of inflation pressure, and huge Treasury supply was priced into the bond markets with much higher yields than back in October 2021 by the time the fiscal stimulus legislation had worked its way through Congress and to the desk of the President.

Figure 4: 10-Year Treasury Yields

Figure 4: 10-Year Treasury Yields

Figure 5: Yields Relative to Inflation

Figure 5: Yields Relative to Inflation

What happens next to Treasury note and bond yields depends critically on inflation expectations. From low levels during the height of the pandemic in 2020, inflation expectations as gauged by the breakeven inflation rate embedded in the prices of U.S. Treasury Inflation-Protected Securities (TIPS), have now risen to 2.5%. We note, though, that historical core inflation metrics are still stuck below 2%.

We also have observed that despite Fed guidance that it plans to allow for considerable overshooting of its 2% inflation target before even considering raising short-term rates or cutting back its asset purchase programs, expectations for an increase in the federal funds target rate 24 months into the future have been rising just a little.

The jury is still out on the future path of inflation, but the fusion of fiscal and monetary policy in a highly accommodative stance has some market participants giving more weight to the rising inflation scenario. The American Rescue Plan Act of 2021 has underscored the possibility of future inflation down the road in a post-pandemic world.

Figure 6: Breakeven Inflation Expectations

Figure 6: Breakeven Inflation Expectations

Figure 7: Historical Core Inflation Still Below 2%

Figure 7: Historical Core Inflation

Figure 8: Fed Funds Rate 24-Months Out Edging Higher

Figure 8: Fed Funds Rate

Figure 9: Implied Fed Funds Rate 2-Years Ahead

Figure 9: Implied Fed Funds Rate 2-Years Ahead

Appendix: Financial Details of the American Rescue Plan of 2021

Appendix:  Financial Details of the American Rescue Plan of 2021

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

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