President Joe Biden inherits an incredibly complicated economic portfolio from his predecessor, Donald Trump, with soaring stock prices and near-term optimism for a pandemic rebound clouding record-high debt levels and creeping inflation.
The latter may prove a more significant challenge for the new President, however, as his early ambition of a $1.9 trillion stimulus effort, aimed at ensuring the economy's long-term pandemic recovery, will likely push overall debt levels past $30 trillion.
That's a staggering 57% increase from levels seen in the early days of the Trump administration, swelled by corporate tax cuts and below-trend growth, and exacerbated by costs linked to the onset of the pandemic last year and the ensuing myriad of relief efforts.
An infrastructure bill, the Congressional version of a four-leaf clover in that it's often sought but rarely found, could take that total even higher.
Convincing lawmakers to pass legislation that adds trillions more while putting off tax increases that could at least mop up some of the extra largesse, appears to be item number one of the to-do list of Biden's Treasury Secretary nominee, Janet Yellen, who pleaded with Senate leaders last Tuesday to lock in rock-bottom interest rates before it was too late.
"Neither the president-elect nor I, proposed this release relief package without an appreciation for the country’s debt burden," Yellen said during her confirmation hearing in Washington. "But right now, with interest rates at historic lows, the smartest thing we can do is act big. In the long run, I believe the benefits will far outweigh the costs, especially if we care about helping people who’ve been struggling for a very long time."
And it's here where things get complicated -- and not just for the President.
Increased government spending is an unambiguous benefit for stocks, with direct payments and business relief cycled into the economy at the quickest rate. But it's also inflationary, given its velocity, and that's never good for the other side of the investment ledger: fixed income markets.
Inflation is the so-called "enemy of bonds" because it erodes the value of future payments. And its effect is even more pronounced on longer-term bonds, which the Biden Treasury is likely to rely on in the coming years.
In fact, the new spending commitments, alongside legacy costs linked to tax cuts, will mean the Treasury will likely issue a record net of $1.84 trillion in new bonds this year, according to JPMorgan Chase, a figure that's more than four times last year's total.
Market reaction to these twin dynamics has been relentless: benchmark 10-year Treasury bond yields have been rising by an average of 8 basis points a month since last August, while inflation expectations in the rate markets are pricing in a 2.09% annual inflation rate for the next ten years, compared to its current pace of 1.4%.
Bank of America's January Fund Managers' Survey, an industry benchmark, noted that 90% of its 194 respondents, who control around $561 billion in assets, see faster inflation and higher bond yields for most of the year.
So, with more debt coming, and more inflation expected, bonds wouldn't seem to be the best bet under a Biden White House.
Or are they?
One key attraction to U.S. bond market weakness is that they draw the interest of foreign investors looking for higher rates of return on risk-free assets. With some $18 trillion in global government bonds currently trading with negative yields -- including all outstanding German government bonds -- as central banks around the world hold rates at record lows and hoover up trillions in debt through quantitative easing programs, the current 1.1% return on 10-year Treasury notes is a steal.
In fact, in a sale of 30-year bonds by the Treasury earlier this month, foreign buyers scooped up 68.6% of the $24 billion available for auction, with bids totaling $2.47 for every $1 on offer.
So the demand for new paper is unlikely to be a problem, given both foreign demand and the Federal Reserve's recent commitment to continue buying $120 billion worth of Treasury and agency bonds each month in order to ensure the smooth running of rate markets.
Inflation, as well, is only likely to accelerate if the economy is growing quickly, and even then, a 2% rise in consumer prices is easily absorbed by market participants when future disinflation -- in the form of robotics, artificial intelligence, clean energy advancements and swifter technological advances -- get bigger in the window.
Biden's Republican rivals are likely to leverage headlines noting the record increase in the national debt, while inflation hawks will continue to shout 'fire' in the metaphorical theatre as consumer prices creep higher, but neither will trigger significant changes to his economic policy.
Nor will they presage any major collapse in bond prices, nor a corresponding spike in Treasury yields. And if economic growth rates exceed borrowing costs -- JPMorgan forecasts a 5.5% GDP gain this year, well more than double Wall Street's 1.7% debt servicing projection -- Biden's new borrowing will more than pay for itself.
And that, once again, is bullish for stocks.