COVID | Fiscal Policy | Politics & Geopolitics | Rates | US
A Smaller COVID Relief Deal and Yellen’s Funding Dilemmas
- By Dominique Dwor-Frecaut and George Goncalves
- 3 min read
The next COVID relief plan has two options for adoption. Either it gets 60 senators’ support or it goes through the budget reconciliation process, which requires only a simple majority. But the Democrats have just 50 Senate seats, which gives the moderate Democratic senators a de facto veto on any bill adopted through budget reconciliation. Moderate Democratic senators have already expressed discomfort with the size of President Joe Biden’s bill and its lack of targeting.
Therefore, as Table 1 shows, a bill passed under reconciliation is likely to be much smaller than the $1.9tn Biden bill. At the same time, reconciliation will probably bring about a larger bill than bipartisanship because moderate Democrats are less fiscally conservative than GOP senators. My estimate for the bipartisan scenario is $700bn, in line with the $600bn that 10 GOP senators offered on 30 January.
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
Summary
- A bipartisan COVID relief deal around $700bn appears most likely. This is due to moderate Democratic senators’ de facto veto and to President Biden’s commitment to fostering national unity.
- Against this backdrop, Treasury Secretary Yellen must navigate perceptions in DC around looking like a big deal is coming relative to the usage of the TGA and T-bill strains versus terming out the debt.
Market Implications
- Risk markets are in danger of disappointment from a smaller deal, though curves will eventually steepen.
Next COVID Package Likely Much Smaller Than Biden’s Plan for $1.9tn
The next COVID relief plan has two options for adoption. Either it gets 60 senators’ support or it goes through the budget reconciliation process, which requires only a simple majority. But the Democrats have just 50 Senate seats, which gives the moderate Democratic senators a de facto veto on any bill adopted through budget reconciliation. Moderate Democratic senators have already expressed discomfort with the size of President Joe Biden’s bill and its lack of targeting.
Therefore, as Table 1 shows, a bill passed under reconciliation is likely to be much smaller than the $1.9tn Biden bill. At the same time, reconciliation will probably bring about a larger bill than bipartisanship because moderate Democrats are less fiscally conservative than GOP senators. My estimate for the bipartisan scenario is $700bn, in line with the $600bn that 10 GOP senators offered on 30 January.
These are the key differences between the Biden plan and the bipartisan and budget reconciliation scenarios:
- State aid: as in the December package, we assume GOP senators would reject aid to states. This is because, economically, red states weathered the pandemic better than blue states, and the Biden plan’s ask of $370bn is misaligned with states’ funding needs. By contrast, we expect moderate blue senators to sign off on some aid to states – but lower than the Biden plan’s ask.
- Household aid: the lower levels we expect under our scenarios reflect demands for better targeting from both GOP and Democratic senators. Simultaneously, we expect household aid to be greater under the reconciliation than bipartisan scenario, reflecting GOP’s and Democrats’ different preferences on fiscal restraint and poverty alleviation.
While prospects for a bipartisan deal look uncertain at this stage, it remains my base case scenario. Progressive Democrats are already adding new provisions to the Biden plan that will be unacceptable to moderates. In addition, Senator Sanders, the chair of the budget committee, wants to change reconciliation rules to allow for the adoption of non-budget-related measures, to which moderates are unlikely to agree. Reconciliation will probably be more difficult than the Democrats expect. Also, turning the GOP offer down entirely would undermine the credibility of Biden’s commitment to national unity.
TGA and Stimulus, Drivers of UST Debt and Curve Steepeners
The Treasury has several issues to handle in coming months. On the one hand, Treasury Secretary Janet Yellen must balance the potential need for a large stimulus package versus market functioning in T-bills and overall money markets. The potential for negative rates to set in the very front end of the curve is now a material risk.
The US Treasury can source most of the cash it needs for initial stimulus outlays from the TGA. Consequently, sudden declines in less T-bill issuance will leave money market funds with fewer places to park their cash. That said, the pull below zero is hardly Yellen’s main concern. But given her prior role and deep understanding of the implications that this will create as a challenge for the Fed (and given that the Treasury and the Fed are coordinating more), chances are she will be mindful of these interplays.
In our view, just like we saw exiting the financial crisis, the notes program will drive UST debt issuance from now on. One, the notes program has the most amount of auction series that they can boost in size. And two, after large cash raises via T-bills, the Treasury usually relies less on T-bills as they aim to term out their debt profile. However, at the same time, Yellen is not keen on launching a 50-year UST at the start and might save that for later for infrastructure plans. And as Chart 1 shows, if the notes program handles the bulk of the debt load, and if the Fed’s pace of QE-related purchases of notes securities is not increased, this additional supply should lead to steeper curves.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
George is a twenty years fixed income veteran. Over that time he has been an active participant on the research and investment side covering rates, structured products and credit. He worked both on the buy-side and sell-side. He can be reached here.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)