Projecting Government

In an ideal world, analysts and investors wouldn't have to spend much time, perhaps none at all, trying to manage around changes in government policy. In that world, government – be it in terms of spending, taxes, or regulation – would be small and consistent enough to not require much thought.

Unfortunately, we don't live in that world. Government is WAY too big. As a result, we spend more time than we should trying to figure out what the government is going to do next.

Three major issues related to government policy are now looming large among investors' concerns.

First, when is the Federal Reserve going to start tapering quantitative easing (QE)? This one is probably the easiest to answer among the three, with Fed policymakers recently going on record suggesting the Fed will announce a tapering of QE by the end of this year and actual tapering starting in January 2022. Given our forecast of continued solid economic growth and inflation exceeding the Fed's projections, we think the Fed will conclude tapering by the end of 2022, perhaps even by September 2022. In turn, that means the Fed will start considering rate hikes by 2023.

The second question is about fiscal policy, which might still be under debate as you read this piece. The US Senate is voting on a so-called infrastructure bill, which is likely to pass very soon, if it hasn't already in the past several hours. Although sometimes touted by politicians and the media as $1 trillion that is fully paid for without tax hikes, the Congressional Budget Office recently scored it as raising discretionary spending by $415 billion in the next ten years while lifting budget deficits by a total of $256 billion, which means it's not fully paid for.

The key to remember in the near term is that the bill will still have a long way to go after passing the Senate. It looks like Speaker Pelosi will hold the bill hostage in the House until she can get enough votes for a completely partisan (and much larger) spending and tax bill that the left-wing of her party wants. But what if that other partisan bill can't pass in the Senate because some relatively moderate Senate Democrats balk? Put it all together and you have a political Rubik's Cube that will take months to solve.