The US could be gearing up to approve $4 trillion in new spending over the next 10 years. After a substantial recent decline in Treasury yields, strategists at Morgan Stanley think a major fiscal package isn't in the price and that progress towards a substantial pickup in approved government spending could push yields higher.
The $4 trillion-dollar question
“Bond investors should be attuned to the Democrats' deliberations on budget reconciliation. Remember, Democratic leadership in Congress is committed to not moving the smaller $600 billion bipartisan infrastructure bill without the larger reconciliation-driven infrastructure package. And last night, the Democrats announced the size of their reconciliation bill: $3.5 trillion. That means the US is gearing up to approve $4 trillion in new spending over the next 10 years, matching our base case.”
“In our view this would translate to about $250 to $500 billion in federal budget deficit expansion next year. Our estimate’s based on the assumption that Congress may only be able to agree to about $2 trillion in new revenues to offset the planned spending. That would mean that the US would effectively be embarking on another round of fiscal expansion next year. That should have a positive impact on GDP growth, and a positive impact on Treasury bond supply.”
“In short, it should push bond yields higher. This is a key reason we are now suggesting that bond investors would be wise, in the near-term, to focus on shorter maturities in their bond portfolios, and rebalance towards longer maturities once Treasury yields get closer to our year-end targets.”