As the U.S. Census Bureau reported on Aug. 17, retail sales fell by 1.1 percent during July compared to the revised June retail sales figures. This is in contrast to an increase of 20.6 percent between May and July and a 15.8 percent increase for the year-over-year comparison to 2020 for the month of July alone.

The National Bureau of Statistics of China released retail sales figures for July on a year-over-year basis. The agency reported an increase of 8.5 percent for the month, missing the 11.5 percent growth target that many predicted, and lower than the 12.1 percent growth in June. The decrease was attributed to the resurgence of COVID-19.

According to the Centers for Disease Control and Prevention, as of Aug. 22, 73 percent of adults in America have received at least one dose of a COVID-19 vaccination (62.4 percent or 170.8 million adults are fully vaccinated). However, the distribution is uneven, portending the increase in infections, hospitalizations, and loss of life due to COVID-19, especially the Delta variant that is infecting both the unvaccinated and a low percent of the vaccinated. The Kaiser Family Foundation notes that African Americans and Hispanics who are 18 and older make up a significant portion (41 percent) of individuals who are unvaccinated but contemplating whether or not to get the vaccine.

A recent McKinsey & Company study found that if 195 million Americans age 12 and older got the COVID-19 vaccine, which would bring the vaccinated level to 70 percent, this would increase the chances for a more robust economic recovery. The study observed that a successful, broad-based COVID-19 immunization push for the public would speed the recovery by three to six months. This would bring the economy to 2019 levels and generate an additional $800 billion to $1.1 trillion in economic growth.

According to an Aug. 3 publication from The National Retail Federation, the economy’s continued recovery is contingent upon combating increasing COVID-19 infections as retail buyers are concerned about new variants. Even though the Delta variant hasn’t changed individual and retail buyer habits yet, it is negatively impacting their outlook going forward. While inflation is expected to moderate over the next 12 months, a June 2021 University of Michigan survey found that retail shoppers see inflation rising by 4.8 percent.

The Conference Board Consumer Confidence Index takes a broad measure of the economy and the generally expected course of future commercial events. It documents how retail buyers see the economy going forward, what they are likely to purchase in the future, how they will pursue leisure activities, how they see their cost-of-living impacted, the performance of equities, and how interest rates will perform going forward.

The July 2021 Consumer Confidence Survey reported an index of 129.7, slightly above June’s reading of 128.9. As the Conference Board elaborates on this reading, numbers indicate that consumers are still expecting to purchase durable consumer goods.

With mixed economic data and the rate of people opting to take the COVID-19 vaccine in flux, the more people who become fully vaccinated the more likely a full economic recovery will occur, including in the retail sector. 

According to the U.S. Energy Information Administration’s Short-Term Energy Outlook, the June price of $73 per barrel for Brent Crude Oil was up by $5 per barrel over May. With more vaccinations being rolled out, uncertainty over OPEC+’s production moves, and a reduction in worldwide oil availability, the outlook for oil prices seems upward. If the price of energy – especially oil – keeps increasing, will it halt the improving economy in its tracks?

As part of the commodity boom, crude oil is not immune from the rapid rise, creating an increase in inflation that’s subject to contention of being “transitory” or longer-term. Based on the World Bank’s semi-annual Commodity Markets Outlook, the positive price of crude oil is expected to remain at present levels through 2021.

The price of energy is projected to be, according to The World Bank, about 33 percent more in 2021 compared to 2020, when oil averaged $56 per barrel. In fact, The World Bank explained that crude oil is not the only commodity expected to increase in cost, and attributed it to the recovery from the COVID-19 pandemic.

With more economies coming online, fossil fuels experiencing greater demand, and OPEC+ maintaining production cuts, The World Bank projects the price of crude oil to average $60 per barrel in 2022. One noteworthy factor is that although present levels of demand for gas and diesel are nearly at pre-pandemic levels, jet fuel demand is still lacking since air travel is not back to pre-pandemic levels.

However, The World Bank sees lower crude prices in these situations: the pandemic wears on longer than projected; there’s a major change in U.S. shale production; OPEC+ changes its production agreement; or if some combination of these three factors impacts crude oil demand.

U.S. Shale

One noteworthy statistic the International Monetary Fund (IMF) points out regarding U.S. shale production is that before the COVID-19 pandemic, shale oil output reached 2 million barrels annually, versus present-day production of approximately 500,000 barrels. While the Biden Administration has banned drilling on federal land, this shouldn’t impact shale production much. However, it signals a bigger approach with the administration’s statements on green energy.

Based on statistics from the U.S. Energy Information Administration’s (EIA) Drilling Productivity Reports, different regions show changes in oil rig production from July 2020 to July 2021. There’s been an uneven recovery over the 12-month period.

In July 2020, the following regions reported the following regarding oil rig production: Bakken at 1,385, Anadarko at 1,001, the Permian at 824, and Niobrara at 1,460. Looking one year later to July 2021, Bakken hit 2,400, with Anadarko dropping to 993, Permian increasing to 1,234, and Niobrara growing to 1,919.

Factoring in OPEC+

On July 18, OPEC+ agreed to phase out production cuts of 5.8 million barrels per day by September 2022, in response to higher prices. With Brent Crude Oil rising 43 percent between the start of 2021 and mid-July 2021, oil is forecast to hit $80 per barrel during the back half of 2021. They will therefore begin to increase oil supply at a rate of 400,000 barrels per day on a monthly basis, which will eventually reduce prices again.

Unknown Variables

Additional unknowns to the price of crude oil and the economy include projected actions by The Federal Reserve. If The Fed increases interest rates, it increases the strength of the U.S. dollar and decreases the strength of a foreign currency. This, in turn, lowers the cost of oil for U.S. dollar purchases and increases costs in foreign exchange, providing mixed demand for fossil fuel demand.

Another variable, according to the Federal Reserve Bank of Kansas City, is that 16 percent of U.S. white-collar workers are expected to work from home at least twice a week. If the Delta variant increases work from home and overall lockdowns, it could also depress oil demand.

With many unknown variables still present with the COVID-19 pandemic and the impact to commodity prices, including crude oil, the economy at-large will remain touch and go until the globe gets the Coronavirus crisis under control.

The June 16 Federal Open Market Committee (FOMC) meeting Q&A session with Chairman Jay Powell and recent comments from The Fed have signaled two potential inflation rate hikes in 2023. Two days later, James Bullard, president of the Federal Reserve Bank of St. Louis, signaled there could be a rate hike as soon as 2022. With these mixed signals and upcoming FOMC meetings, how might inflation and the markets play out in 2021?

Inflation and the Dollar

One explanation for inflation is that there are too many dollars chasing too few goods – or more simply put, things will cost more over time. Say you can purchase a pair of shoes for $100. Then, inflation is 3 percent over the course of a year, making them cost $103 after one year.

This example illustrates when the cost of things – including school, housing, clothes, food, energy, etc. – increases according to the Consumer Price Index or CPI, as the U.S. Bureau of Labor Statistics defines it.

Some Factors Impacting Inflation

One of the Federal Reserve’s dual mandates is price stability. There are three ways The Fed can steer inflation.

The first is by adjusting the Federal Funds Rate, which determines how much banks pay for overnight borrowing from a “depositary institution,” such as the Federal Reserve Bank. By raising this rate, it lowers spending and helps reduce the likelihood of inflation by tamping down costs, along with pushing up interest rates for lenders.

Another tool is the Fed increasing its Reserve Requirement. By increasing this metric, it slows down spending, and therefore inflation by how much money institutions can lend out.

The third is through open-market operations (OMO), whereby the Fed can either buy U.S. Treasury Bonds to increase the supply of money or sell U.S. Treasury Bonds to decrease the money supply.

The Fed uses the Personal Consumption Expenditures (PCE) Index from the U.S. Bureau of Economic Analysis, along with the Depart of Labor’s Consumer Price and Producer Price indexes, to gauge inflation.

Understanding Cost-Push Inflation

According to the Federal Reserve Bank of San Francisco, there are a few ways to quantify inflation. Cost-push inflation happens when inputs necessary for manufacturing cost more. This can include input resources that cost more or worker pay that rises quickly. During the energy price spike during the 1970s, the increased cost of fossil fuel increased production and commercial hauling costs.

Wage-Push Inflation

According to the Monthly Labor Review, the Bureau of Labor Statistics, the Federal Reserve Bulletin and the American Economic Association, wage-push inflation is the “thesis” that argues employee pay has risen faster than actual good or service output and is squeezing profitability and price attractiveness to consumers.

One reason this occurs is due to a minimum wage mandate. Another reason is to attract better workers or increase their applicant pool. It’s important to know that doing so will increase the money supply in the economy, which will help them purchase more and create a higher demand for goods. This will further increase the price of goods, whereby businesses will charge more for goods to pay higher wages, which will increase the price of goods throughout the economy. It’s all about balancing the wage increases versus the cost of goods.

Demand-Pull Inflation

Demand-pull inflation happens when there’s the classic too much demand but too little supply scenario. It’s often accompanied by an increase in money supply by a loose central bank monetary policy, oftentimes leading to higher prices.

Looking to Commodities

Taking energy, specifically West Texas Intermediate Spot price, due to increasing costs of energy, this sector is projected to do well in an inflationary scenario. Looking at data from the U.S. Energy Information Administration, the price per barrel increased from nearly $45 on Jan. 1 to more than $59 on April 9, to more than $71.55 on June 18 and climbing. Be it stocks, options or futures, investors who took positions earlier in 2021 or 2020 likely benefitted from inflation.

Performance May Vary by Asset

However, it’s important to select the right assets to decrease the likelihood of losses and increase the chances of gains. For example, fixed income, in conjunction with higher interest rates, is likely to decline due to not staying competitive with inflation rates. Using the “discounted cash-flow method” to evaluate a stock, especially in periods of higher interest rates, growth stocks fare worse compared to their value counterparts. When investing in dividend paying stocks, these may provide a hedge against inflation because they oftentimes can pass on higher costs for their products, keeping their earnings in line with growth expectations, along with receiving dividends themselves.

While the future of the market can’t be predicted, paying attention to how the economy reopens and the Fed manages inflation can help determine what investments are the best going forward.

With the economy reopening and more Americans receiving COVID-19 vaccinations, the economy is expected to be operating on all cylinders. However, some economists and market analysts are afraid The Federal Reserve may create a “taper tantrum” if and when it starts to reduce its purchase of U.S. Treasury debt. The Fed’s current track of purchasing $120 billion of U.S. Treasury debt every month has kept the 10-year yield moderated. However, if The Fed signals fewer monthly purchases from current levels, recent history has already seen higher 10-year yields and increased market volatility.

As the Federal Reserve Bank of St. Louis outlines, the Federal Open Market Committee (FOMC) holds meetings eight times a year to evaluate the country’s economic conditions and determine the forward monetary policy. This includes what they will do (or not do) to the federal funds rate, which is the rate that financial institutions charge each other for overnight interbank lending.

Whatever the FOMC decides to do with the federal funds rate, it’s important to know that any changes to the federal funds rate impacts short-term interest rates, such as the three-month Treasury bill. Depending on how it’s modified (increased or decreased), the rate change impacts consumer and business loans and longer-term debt.

When the FOMC raises or lowers the federal funds rate, it sends a policy directive specifying the new target range to the trading desk of the New York Fed. Depending on the target rate of the new fed funds rate, more government securities will be bought to lower the rate, or government securities will be sold to raise the new target. This is accomplished through its open market operations (OMO).

OMO is made up of two parts. The Fed buying or selling U.S. Treasury bonds, for example, consists of the operations part of OMO. Since the Fed relies on the trading desk of the New York Fed to accomplish its goals, it uses the open market to purchase these securities through the traditional bid and offer trading method. It’s one tool in its toolbox to accomplish the dual mandate policy of maximizing employment and maintaining price stability.

Depending on which way the Fed goes – either tightening or loosening its policy – it tries to steer the level of the banking system’s reserves, creating a shift in interest rates. For example, when the Fed buys Treasury bonds, it adds capital to the purchasing bank’s reserve balance to increase lending through lower interest rates. When the Fed sells its U.S. Treasury bonds, it moves the federal funds rate upward. This lowers banks’ reserves, causing financial institutions to increase lending costs.

When it comes to the term “quantitative easing,” the Federal Reserve Bank of St. Louis defines it as “large-scale operations of the purchase of large amounts of longer-term U.S. Treasury securities and mortgage-backed securities.” One noteworthy consideration for OMO is that when the federal funds rate is near zero, which occurred during the 2008-2009 financial crisis, quantitative easing is one more tool in the Fed’s toolbox to help the economy dig itself out of a downturn and provide liquidity.

Tapering in Action

According to the Federal Reserve Bank of St. Louis, when tapering was even mentioned, it had negative effects on the markets. After continued quantitative easing was instituted to rescue the economy from the 2008-2009 financial crisis through part of 2013, the Fed made comments regarding these efforts in its FOMC meeting and during its press conference on June 19, 2013. It indicated that it would begin “tapering” (gradually lessening) its monthly bond purchases during the end of 2013, assuming economic conditions were improving. However, the market reacted badly to these comments.

U.S. 10-year bond yields spiked to 2.35 percent within hours of the FOMC meeting and press conference on June 19, 2013. On June 21, 2013, the 10-year bond yields climbed farther to 2.55 percent. Similarly, the same meeting prompted a spike in “normalized foreign exchange per USD rates,” according to the St. Louis Fed. In the two days from June 19-21, 2013, the U.S. dollar gained between 2 percent and 3 percent in value against the Euro, the British pound, the Canadian dollar, and the Japanese yen.

Conclusion

Looking at markets on June 19, 2013, when the Fed announced the tapering, the Dow Jones fell more than 200 points, the S&P dropped 1.4 percent and the Nasdaq finished 1.1 percent lower.

Retail and institutional investors can’t predict the future, but they can look at the past and monitor upcoming Federal Reserve events to see what it might end up doing to the stock market.

Based on data from the Federal Reserve Bank of St. Louis, the spread between the 10-year and two-year constant maturity Treasury rates increased by 66 basis points – from 0.48 percent in July 2020 to 1.14 percent by February 2021. Due to the Federal Reserve’s open market operations, two-year notes have fallen to near 0 percent, while the 10-year yield has risen higher.

Experienced investors and financial institutions such as the Federal Reserve Bank of St. Louis would see this change in the slope of the yield curve of the two U.S. Treasury rates and call it a steepening yield curve. This recent widening spread illustrates what a steepening yield curve looks like and how it impacts the economy moving forward.

The Federal Reserve Bank of St. Louis attributes the steepening yield curve to fiscal stimulus and the mass adoption of COVID-19 vaccinations. These two factors could be indicative of future economic growth, including stock market earnings and job gains.

The Yield Curve as Predictor

When it comes to the yield curve and employment, the Federal Reserve Bank of St. Louis explains how the two are related.

Employment growth mirrors the spread in the 10-year and two-year Treasury notes. When the yield curve first steepens, employment numbers might be negative. However, because the steepening yield curve projects increased economic growth, employment growth will soon follow a similar positive growth trajectory.

Historically speaking, the association between the yield curve’s increasing spread and future economic growth keeps its positive trajectory movement over time. This association, based on historical data from the Federal Reserve Bank of St. Louis, has been able to project between 18 months and 36 months of positive future economic growth and approximately 30 months of a positive yield spread and employment growth trend.

While the Federal Reserve Bank of St. Louis is uncertain about much inflation will accompany the economic expansion, it is confident that the Federal Open Market Committee (FOMC) will  keep short-term interest rates low to contain borrowing costs and help boost strong financial markets through projected positive economic growth going forward.

Widening Yield Curve and Bank Earnings

As the Federal Deposit Insurance Corporation (FDIC) explains, banks benefit from a steep yield curve because they engage in maturity transformation. The New York University’s Leonard N. Stern School of Business defines maturity transformation as when banks borrow short-term and lend long-term. This lets banks profit from the mean of the short- and long-term rates, the so-called term premium. Term premium is how much premium long-term government bond holders realistically anticipate they will receive versus a string of short-term bonds that might have differing interest rates. Buyers of long-term bonds receive payment in exchange for the uncertainty of changing short-term interest rates.

A widening yield curve also can impact a bank’s net interest margin. According to the Federal Reserve Bank of San Francisco, net interest margin is what’s left over for the bank after deducting interest expenses from interest income. Donald Kohn explains that if short-term interest rates increase, interest costs accordingly increase to interest income. This would lower net interest margins as well as the bank’s holdings.

Assuming there are no further negative economic headwinds, history tells us there is a reasonable expectation of an economic resurgence from the coronavirus pandemic.

As the January 2021 World Bank Pink Sheet documented, prices increased month-over-month from November 2020 to December 2020. Highlights include the price of oil jumping by 15 percent. The cost of fertilizer jumped 2.2 percent, grains increased by 3.8 percent and iron ore jumped by 25 percent. While there’s been no official “commodity super-cycle,” according to economists or financial analysts, the trend certainly shows commodity prices increasing.

2020 caught the world off-guard with the coronavirus pandemic, sending the price of oil negative. According to Rice University’s Baker Institute for Public Policy, on April 20, 2020, “the prompt contract price” or how much a barrel of West Texas Intermediate (WTI) cost for May 2020 deliveries went negative, falling $50. It eventually rebounded to $45 per barrel in November as vaccine optimism began to take hold.

For other commodities, the story was not as bad, signaling what might be another commodity super-cycle. On Aug. 4, 2020, gold broke the $2,000 mark. With central banks and governments spending to support the economy due to the pandemic, it put pressure on global currencies. For example, with the U.S. dollar index dropping nearly 10 percent from March 2020 to August 2020, precious metals such as gold became a hedge against inflation.

Many would assume that commodities surged in part from the economic damage of COVID-19 but, looking at the data, commodities were seeing a resurgence at the start of 2020 – well before the pandemic negatively impacted the global economy.

With data as recent as March 5, the International Monetary Fund shows how commodities changed before the pandemic, during, and as the recovery is underway for the first two months of 2021. Looking at the IMF’s “Actual Market Prices for Non-Fuel and Fuel Commodities” chart, one can see how commodities bottomed out during the pandemic and are showing signs of significant growth.

One metric ton of wheat was $186.10 in 2018, $163.30 in 2019, $185.50 in 2020. In Q1 of 2020, it was $173.80, Q2 was $174.80, Q3 was $183.00, Q4 of 2020 was $210.5. Then the first two months of 2021, one metric ton of wheat was $237.90 and $240.80, respectively.

For metals, one metric ton of copper was $6,529.80 in 2018, $6,010.10 in 2019, $6,174.60 in 2020. In Q1 of 2020, it was $5,633.90, Q2 was $5,350.80, Q3 was $6,528.60, Q4 of 2020 was $7,185.0. The first two months of 2021, the price was $7,972.10 and $8,470.90, respectively.

Spot Crude priced per barrel in U.S. dollars was $68.30 in 2018, $61.40 in 2019, $41.30 in 2020. In Q1 of 2020, it was $49.10, Q2 was $30.30, Q3 was $42.00, and Q4 of 2020 was $43.70. Then the first two months of 2021, Spot Crude was $53.50 and $60.50, respectively.

For the Spot Crude figures, the IMF uses the Average Petroleum Spot Price (APSP), which averages equally three crudes: West Texas Intermediate, Dubai, and Brent.

Will China Lead the Globe’s Super-Cycle?

As the United Nations defines it, a super-cycle is when there’s a paradigm shift toward increased demand, lasting at least a decade and up to 35 years “in a wide range of base material prices.” It focuses on “industrial production and urban development of an emerging economy.”

Looking at China could signal what the globe will follow economically. According to Refinitiv, China saw a positive growth of 2.3 percent of its GDP in 2020, compared to the global average of -3.5 percent. As the world emerges from the pandemic, it will undoubtedly consume more commodities. When it comes to 2021 GDP expectations for China, the World Bank expects the country to grow by 8 percent to 9 percent.

Looking forward to 2022, Eikon predicts that China’s GDP will grow by 1.6 percent more than the rest of the world, and 3.1 percent higher than America’s GDP expected growth rate in 2022.

Much like the pandemic was not in anyone’s economic forecast, if the global economy is in a commodity super-cycle, savvy investors will be ahead of the curve if a super-cycle materializes. 

Now that the Keystone XL pipeline is being shut down and southern parts of the United States are experiencing extremely cold weather, how will increasing oil prices impact the economy as the COVID-19 vaccine is being rolled out?

With West Texas Intermediate (WTI) crude closing at $58.22 per barrel on Feb. 11, 2021, and likely higher due to the cold snap in the United States, the price of oil is expected to impact the U.S. and global economy.

Consumer Demand

One of the major impacts of increasing oil prices is the rising price of gasoline. With higher oil prices rippling throughout the economy, understanding how it impacts consumers is one way to see how the economy in 2021 is likely to perform.

As the Federal Reserve Bank of San Francisco points out, there’s a close correlation in pricing between gasoline and crude oil pricing. They point out that WTI and what American consumers pay for gasoline to fill up their car track each other quite closely — as oil prices increase, so do consumer prices for gasoline.

Historic Price Trends in Relation to Today

When it comes to looking at how oil prices impact inflation, looking at historical prices gives helpful insight. In the 1970s, the price of oil increased tenfold, from $3 in 1973 (pre-oil crisis) to more than $30, due to Middle East tensions in 1978-1979 resulting from the Iranian Revolution, according to The Federal Reserve and the U.S. Energy Information Administration (EIA).

However, as time progressed beyond the two oil crises of the 1970s, this correlation became weaker. When the 1980s began, so did the association between oil prices and rising inflation. The U.S. Bureau of Labor Statistics (BLS) explains this rapid increase in the cost of oil drove the consumer price index (CPI), one way to measure inflation, from 41.20 in the beginning of 1972 to 86.30 as 1980 came to a close. As the BLS illustrates how the 1970s experienced high inflation, it took three times as long (24 years) for the CPI to double between 1941-1971.

With the two Oil Shocks passed, the 1980s and the 1990s ushered in a new divergence of how oil prices ultimately impacted what consumers paid for oil and oil-dependent products. This is illustrated by looking at the impact of the Producer Price Index (PPI), or wholesale cost, versus how consumers ultimately felt, or the Consumer Price Index (CPI).

CPI and PPI Data and Oil Prices

Looking at the CPI, especially in the 1990s, statistics from the EIA show that the price per barrel of crude oil went from $14 to $30 in six months. However, data from the BLS shows that CPI started at 134.6 in January 1991, eventually reaching 137.9 in December 1991.

Later, from 1999 to 2005, the EIA’s data shows the price of a barrel of oil jumped from $16.50 to $50. While the price nearly tripled, the BLS’ CPI jumped from 164.30 in January 1999 to 196.80 in December 2005, an increase of 33.5 over nearly six years.   

Looking at the Producer Price Index (PPI) data, per the Federal Reserve Bank of St. Louis, from 1970 to 2017, the correlation was 0.71. For the CPI, during the same time frame, it was only 0.27. The difference between the CPI and PPI, according to the Federal Reserve Bank of St. Louis, is due to the higher proportion of services provided in the United States, which are less oil-reliant for raw materials.

External Factors

With the expected relief payment of $1,400 per individual and additional money allotted for dependents, coupled with continuing vaccinations and the reopening on the U.S. and global economies, there’s much stimulus expected to provide consumers with a financial cushion. However, with the increased spending by the federal government and pressure on the U.S. dollar, only time will tell how the price of crude oil will impact consumer spending and company earnings.

About four in 10 Americans (41 percent) look positively toward single-party control at the national level, according to an October 2020 Gallup annual governance survey. This is compared to 23 percent of respondents desiring multiparty control. Breaking it down by party, 43 percent of Democrats want single-party rule, while 52 percent of Republicans desire single-party governance.

One notable finding is that, looking back to 2002, 32 percent preferred single-party control when it comes to independents. This was the highest-ranking over the past 18 years. As the Brookings Institution points out, now that Jon Ossoff and the Rev. Raphael Warnock are U.S. Senators, the U.S. Senate is divided 50-50 with Vice President Kamala Harris able to break a tie. According to political experts’ forecasts, President Joe Biden is likely to accomplish much of his agenda in light of these circumstances.

However, as the Brookings Institution notes, many are expecting West Virginia Sen. Joe Manchin to be the deciding vote on many upcoming pieces of legislation in 2021. His track record proves he’s been a wildcard depending on the legislative topic at hand.

When Manchin was West Virginia’s governor from 2005 to 2010, he lowered taxes, gave teachers higher salaries, helped repair the state’s worker compensation system, and reduced the state’s overall liabilities. He’s opposed to adding additional justices beyond nine (other than replacing justices who have retired or passed away) and is against reducing funding for public safety needs. Yet, he did not support President Trump’s tax cuts in 2017, nor did Manchin have any interest in reducing the scope of the Affordable Care Act.

President Biden Tax Proposals

If President Biden’s proposed legislative priorities on the campaign become a reality, they will undoubtedly impact personal and publicly traded companies’ earnings. According to The Tax Foundation, Biden proposes increasing the highest personal marginal income tax rate to 39.6 percent from 37 percent. He’s also expected to advocate changing the highest corporate income tax rate from 21 percent to 28 percent.

Additional proposals include taxing capital gains at 40 percent for those who earn $1 million or more, along with The Tax Foundation reporting the potential for at least a tax of 15 percent on income that publicly traded companies disclose on financial statements available to equity holders.  

Implications of Tax Cuts (and a Lack Thereof)

According to Stanford Graduate School of Business and research done by Rebecca Lester, associate professor of accounting at Stanford Graduate School of Business, there are some insightful findings on how tax policy impacts corporations’ bottom lines.

One of the primary findings is that while companies take some of the increased savings from fewer taxes and deploy it outside the United States when it comes to using it domestically, it’s used for automation, not to create additional employment opportunities.

For example, the Domestic Production Activities Deduction (DPAD) gave companies a tax deduction that would essentially lower their income tax obligations on earnings from domestic manufacturing. However, there was no requirement to increase domestic manufacturing or employ more Americans.

Based on this example, companies cannot only save money directly from the tax cuts but also indirectly through long-term gains via automation. Looking forward to how a Biden Presidency will shape corporate earnings and the resulting market performance will likely depend on how a few moderate Senators vote. 

The Obama and Trump administrations couldn’t have had a more different approach when it came to U.S. relations with China. As the Institute for China-America Studies (ICAS) explains, under the Obama administration, the United States favored a trade and investment approach when dealing with China, while the Trump administration had a national security focus. The ICAS believes the Biden administration will address trade and economic imbalances through a modified approach, including reducing tariffs on imported Chinese goods over time to decrease inflation for American consumers. Another example is maintaining pressure on China to cut government subsidies for competing industries, currency games, and exporting products to the United States at artificially low prices.

While the Obama administration engaged China through trade and investments, it didn’t emphasize engaging the country on the national security side. The Trump administration looked to make American industries independent of Chinese production, especially for rare earth metals, pharmaceutical precursors, etc. With the inauguration of President-elect Biden, the incoming administration is expected to maintain the Trump administration’s quest to give many American industries a fighting chance of survival, albeit how it will be accomplished will likely vary.

The Biden administration is projected to lower tariffs on Chinese imports gradually. This is expected to be done to reduce the tension of the existing trade war. It’s also expected to be done to lower the rate of inflation and help businesses that import input materials from China.

Based on statistics according to the American Action Forum, approximately $57 billion was paid by consumers on an annual basis per 2019 import numbers, due to tariffs instituted by President Trump. This action is likely to increase consumer spending and increase companies’ earnings. However, the Biden administration is still expected to keep other forms of trade pressure on what many believe are unfair trade practices by China.

Biden also is expected to raise the same concerns the Trump administration did regarding Chinese trade and commerce, including China subsidizing its industries, flooding the American market with goods to undercut American producers, and requiring so-called forced technology transfers from U.S. companies.  

However, the trade deficit the U.S. has with China isn’t expected to see much attention. This could negatively impact how much China is ultimately expected to import from the United States.

When it comes to colleges and universities, research-based collaboration, and artistic-based areas, relations are expected to be more friendly. However, when it comes to fighting China’s human rights violations, individuals or business entities might be targeted. Based on Vice President-elect Kamala Harris’ proposed Uyghur Human Rights Policy Act of 2020, there’s an expectation the Biden administration will keep the pressure on China.

Beginning in 2017, Biden began to discuss plans for America and how some of America’s crucial industries could be more self-sufficient and less reliant on China. Examples include pharmaceutical products, medical equipment, and rare earth minerals.

Potential actions the Biden administration could implement against China include sanctions; U.S. government-sponsored legal action against Chinese firms; and becoming more involved in the World Trade Organization (WTO) and similar organizations. This is seen by some as the U.S. becoming more in-step with Europe to better pressure China in WTO and related disputes. It might also include courting America’s allies in reducing or prohibiting Chinese investment of domestic industries to make it more difficult for Chinese firms to obtain cutting-edge technology.

While there is no way to accurately predict how the Biden administration will treat China, there will likely be continued pushback on China. How these actions will ultimately impact trade and the markets will be seen in the near future.

With the nation on the precipice of a transition of administrations on Jan. 20, 2021, there will need to be many roles filled both in and out of the White House. With the potential for Janet Yellen to replace Steven Mnuchin as the next treasury secretary, there is much speculation about how the Federal Reserve will be shaped by the Biden administration.

Predicting Changes to the Federal Reserve

When 2022 arrives, Chair of the Federal Reserve Jerome Powell’s term will expire. While presidents have historically given another term to first-term chairs who were appointed by the outgoing administration, there is no indication that Powell will stay on for another year. President Trump deviated from this norm when he appointed Powell to replace then-Chair Janet Yellen. Originally appointed by Obama to the Fed in 2012, Powell was first a Fed governor and a Republican politically.

First Vice Chair Richard Clarida’s term expires in January 2022. Vice-Chair of Banking Supervision Randal Quarles’ term expires in October 2021. Both vice-chairs are expected to be replaced when their terms are up.  

With two Fed board seats still unfilled, and if the Biden administration nominates Fed Governor Lael Brainard to become the next Treasury Secretary, it would create a third Fed board seat opening. Brainard is favored as a strong candidate because many economic experts see a need for the Fed and the U.S. Treasury to work together closely.    

While President Trump attempted to fill one of the empty Fed seats with Judy Shelton, on Nov. 17, the U.S. Senate declined her nomination to sit on the Federal Reserve Board of Governors; Christopher Waller still could be confirmed during the Senate’s post-election session. Assuming he doesn’t get confirmed before Congress adjourns and 2020 closes, the nomination will expire.

What’s Not Expected to Change

When it comes down to how the Fed handles monetary policy, chances are things won’t change much from the current status quo. Since the U.S. economy is still in a malaise due to the harmful effects of the COVID-19 pandemic, the Fed has made a crystal-clear statement that interest rates will remain at “near zero” for the next 36 months, at a minimum.

In August 2020, the Fed announced that it’s recommitting itself to maintain existing rates as the economy emerges from the downturn for a longer period of time, compared to past Federal Reserve efforts to spur economic growth. Then on Nov. 5, the Federal Reserve’s FOMC Statement reinforced that the federal funds rates will stay at 0 percent to ¼ percent, as long as economic growth is threatened.

Promoting Diversity

Part of the Democrats’ legislative agenda is for the Fed to take action to reduce racial inequality. The objective is for this to become part of the Fed’s existing mandate, which currently includes price stability and maximum employment. If President Biden endorses this legislation, it would likely have an even greater impact on the Fed.

Another thing to consider is that Biden is expected to appoint more minorities to the FOMC, which, with the exception of Janet Yellen serving a four-year term, has been all white men.

Many at the Fed already recognize the importance of including all Americans in opportunities to benefit from a robust economy. During August 2020, the Fed announced that it is taking its time boosting interest rates, in contrast to how it handled past economic challenges, in order to produce an economy that favors job seekers, especially minorities.

Chairman Jerome Powell explained to the media that the Fed is ready and able to implement its financial instruments to prop up the economy and ensure that the country’s emergence from COVID-19 will be assisted. Powell has called on Congress to pass more stimulus, especially to help those who lost jobs from the pandemic.

Depending on who is selected and confirmed as treasury secretary, there could be a renewed hope for recently discontinued stimulus programs, some in conjunction with the Fed. In a letter dated Nov. 19, Treasury Secretary Steven Mnuchin indicated to Jerome Powell the following Federal Reserve programs that will cease functioning on Dec. 31, 2020:

• Program 1: Primary Market Corporate Credit Facility (PMCCF)
• Program 2: Secondary Market Corporate Credit Facility (SMCCF)
• Program 3: Municipal Liquidity Facility (MLF)
• Program 4: Main Street Lending Program (MSLP)
• Program 5: Term Asset-Back Securities Loan Facility (TALF)

Funded via Congress’ CARES Act, these programs give the Fed the power to loan as much as $4.5 trillion to markets.

Naturally, this move is currently opposed by the Fed because it takes away additional tools that can be deployed to support the economy and its underlying financial systems. Treasury Secretary Mnuchin’s actions will return $429 billion from the Fed to Congress to be re-appropriated.

One program that will be lost is the MSLP, which was recently modified to give loans as small as $100,000 per applicant. With no more access by year-end, this will likely impact smaller businesses.

It is noteworthy that the following programs were extended for an additional 90 days after Dec. 31, 2020. These include Commercial Paper Funding Facility (CPFF), Market Mutual Fund Liquidity Facility (MMLF), Primary Dealer Credit Facility (PDCF), and Paycheck Protection Program Liquidity Facility (PPPLF), used to shore-up money market liquidity. Though, depending on who is the treasury secretary in 2021, there might be a reconsideration of any or all of these programs.