Fixed income market update

What impact can we expect US fiscal stimulus plans to have on interest rates?

The ambitious stimulus packages unveiled in the US – starting with the $1.9 trillion relief plan and followed up by a $2.5 trillion infrastructure plan – draw two questions. The first relates to their reflationary capacity and the second to their financing. Both, in turn, prompt questions about their possible role in sending US interest rates upwards.

We want to give you our take on this burning issue.

In response to the reflationary question, we are still not buying the scenario of a sustained rise in inflation above 2.0% / 2.5% and continue to believe, like the Fed, that the uptrend in inflation statistics is temporary.

There are a number of reasons for this.

For starters, the cheques that the US Treasury has issued to American households in recent months have led to an increase in savings rather than consumption, which has not sparked any inflationary pressures. Secondly, the infrastructure plan must first be approved and will, in any case, be spread over a number of years. This could also lead to an increase in production capacities. This suggests that there is little chance of the plan having any lasting inflationary impact either.

Lastly, the acceleration of job creation and the fall in US jobless numbers to around 6% are encouraging signs for the economic recovery, but still a far cry from a full employment situation. It is therefore too early to contemplate wage pressures that would lead companies to pass on their rising costs and send consumer prices higher.

When it comes to funding this fiscal stimulus, a portion is likely to be financed by additional tax revenue (and more specifically by raising the US corporate income tax rate). Naturally, the rest will need to be funded by increased US debt, which means that the US Treasury will have to step up its issues. However, we would not expect this to send rates soaring either.

This is mainly because demand remains strong and the main buyer (the Fed) is continuing to purchase $120 billion worth of assets per month, including $80 billion in Treasuries. Concern over an end of these purchases (spectre of another “taper tantrum”) seems a little premature. Besides, the more attractive level of US rates is drawing a flow of buyers from among international institutional investors who had recently shied away from US debt. This is also one of the reasons for the recent dip in US long rates, leading US 10-year yields to slip by 15bp in the last two weeks to 1.60%.