Infrastructure Month

The regional Philadelphia Fed manufacturing index surged from 23.8 in October to 39.0 in November. New orders, shipments, unfilled orders, prices paid, and prices received each jumped. Inventory levels fell as consumer demand remained strong. When combined, regional business surveys have been pointing to a potential rise in the national ISM manufacturing index, which is closely watched by financial markets.

Austria announced that it would re-enter a national lockdown as Covid cases have once again started to surge. While about 2/3rds of the country has been vaccinated, that rate is low compared to most of the western European countries. The country will also mandate vaccines for everyone on February 1st. Germany has also indicated that it may follow suit if the number of cases does not improve. Austria’s announcement pushed down reopening stocks and boosted technology stocks, but we do not see this as a lasting trend as a U.S. lockdown ahead of the 2022 U.S. mid-term elections seems unlikely.

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“Infrastructure week” has quickly become infrastructure month (perhaps even months) with Congress still trying to get President Biden’s heavy legislative agenda off the ground. On November 15, 2021, President Biden did sign into law the Infrastructure Investment and Jobs Act, which is the traditional $1 trillion infrastructure bill that is aimed at improving the quality of the nation’s infrastructure (see figure 1). However, the larger $1.7 trillion Build Back Better Act remains in flux.

This chart highlights the ranking between the top 15 countries with the best infrastructure worldwide. The U.S. ranks 13th in the world in quality of overall infrastructure

The House of Representatives did pass its version of the bill on November 19th, but it still must go to the Senate. The House vote came after a scoring from the nonpartisan Congressional Budget Office, which showed that the bill would potentially cost $1.68 trillion over 10 years and raise $1.27 trillion in new revenue – accruing a $367 billion deficit between 2022 and 2031. However, this excludes a potential $207 billion in revenues that could be generated by enhanced Internal Revenue Service (IRS) enforcement. If included, the expected increase in the deficit shrinks to approximately $160 billion.

Importantly, these numbers could still change with the Senate likely to alter the bill. The four-weeks of paid leave provision will likely be stripped out, the $100 billion set aside for immigration reform will likely be eliminated by the Senate parliamentarian, and the cap on the state and local taxes (SALT) may be tied to income. For example, the cap on the SALT deduction could be lifted for those with incomes under $400,000 but remain in place for those making incomes above that threshold.  

Even with these changes, it is still not clear if the bill will pass with rising inflation making additional fiscal spending less popular among some moderate Democrats and weighing on President Biden’s job approval rating (see figure 2).

Importantly, unlike the bi-partisan infrastructure bill that garnered the support of 13 Republicans, the support of every single Democratic Senator is likely going to be needed to pass the Build Back Better Act. That remains a heavy lift and negotiations could easily take until the end of this year.  

Despite these challenges, Citi Research’s economists are putting the probability of passage at about 70%. As a historical reference, 21 of 25 past budget reconciliation bills (or 85%) have went on to be signed by the President. If passed, we do not expect the bill to have a major impact on the economy overall, but it should serve as an incremental tailwind for global supply chains, cable and fiber optic internet companies, and building materials firms. This is already being reflected in financial markets with the Indxx U.S. Infrastructure Development index outpacing the S&P 500’s year-to-date returns by 12.3% (see figure 3).

This line chart shows President Bidens job approval drop whilst the US consumer price index raises from January 2021 to 2021 year-to-date.

This line chart shows the S&P 500 versus the Indxx U.S. Infrastructure Development Index from January 2021 to 2021 year-to-date.

Time to Pick Up the Can

Looking a bit further out, Congress will also need to address the funding of the federal government by December 3rd or face a potential government shutdown of non-essential services and to raise the debt ceiling with the U.S. Treasury saying that it may not be able to fully meet all its obligations beyond December 15th. We suspect that the actual binding hard debt ceiling date may be a few weeks past that date, but either way, Congress can only “kick the can down the road” so far before having to act. While financial markets may begin to once again react as the deadline approaches, the White House and Congress have acted 98 times since the end of World War II to modify the debt ceiling and we have no reason to believe that this repetitive game of chicken will end any differently this time with policymakers likely to swerve at the last minute to avert potential disaster.

Consumer Spending Better Than Consumer Sentiment

Apart from Washington negotiations, other notable developments included U.S. retail sales, which jumped by 1.7% in October on the back of higher prices with gasoline station sales spiking 3.9%. Control group sales, which exclude gas stations, food services, auto dealers, and building materials and are used in the U.S. gross domestic product calculation, advanced by an impressive 1.6%. The key takeaway is that weakening consumer sentiment has yet to translate into weaker economic activity with consumer spending off to a strong start in the fourth quarter.

Following the report, the widely followed Atlanta Fed’s GDPNow tracker rose from 8.1% for the fourth quarter to 8.7%. That level is well above the annualized rate of 4.8% that is being predicted for the fourth quarter by the consensus, but the upward revision coincides with Citi’s U.S. economic surprise index which has been climbing steadily since early November (see figure 4). An accelerating economy and tentative signs of improving supply chains should support equity markets over the near-term.

This line chart shows Citi's U.S. Economic Surprise Index (%) from December 2020 to 2021 year-to-date. It's been steadily raising since August 2021.

Heading into 2022, the path of Fed policy will likely be key to the outlook. While President Biden’s decision to renominate Fed Chair Powell and to elevate Fed Governor Lael Brainard to Vice Chair suggests policy continuality, there are rising expectations that the pace of bond purchase tapering could accelerate after December and a first rate hike could occur as soon as June 2022. This could lead to some market volatility, even though a Fed rate hike should likely be viewed as a confirmation that the U.S. economy remains in a strong position.

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