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Growth At What Cost

The tug-o-war between rising interest rates and potentially strong economic growth continued this week as the 10-year Treasury topped 1.7% (which may not sound like a lot, but represents a 66% increase in the past twelve months).  It’s as if bond investors are daring the Federal Reserve to act sooner rather than later.  Not blinking in the face of this pressure, Fed Chair Jerome Powell again stated this week that the Federal Reserve is staying the course with its current policy.  Eventually, if interest rates go high enough, the Fed will be forced to act.  However, it seems we’re not there yet.

As for the boring details, the Federal Reserve met this week and in its announcement, decided to keep interest rates near zero through 2023.  As mentioned above, there is a war brewing and it is highly probable that the Fed will have to act sooner than it wants.  Despite the vote being unanimous, three members expect a rate increase next year and seven expect a rate increase the following year.  They may have voted to keep its policy unchanged, but clearly some on the board don’t fully embrace the strategy.  As the market turns up the heat, we’ll see if the Fed can keep its unanimity intact.

Let’s talk about the stimulus.  If you qualify, you may have already received a check for $1,400 (per person).  Economists anticipate this money will find its way into the economy in one form or another.  They expect a third to go to savings, a third to go to investments, and a third to go to consumption.  And with that, Wall Street analysts are quickly raising their GDP estimates for the year ahead.  Goldman Sachs now believes economic growth will rise 6% in Q1, 11% in Q2, 8.5% in Q3, and 6.5% in Q4, which implies 7% growth for 2021 on a full-year basis.  However, this growth doesn’t come without consequences, namely the risk for inflation.  Hence, we’re right back to where we started with a tug-o-war between rising interest rates and strong economic growth.  It also explains why the market seems to be churning a bit more than usual while investors try to figure out which will win out.

There’s one more thing to consider.  This latest round of stimulus won’t be the last.  An infrastructure package is in the works and if reports are true, it will fall between two and four trillion dollars.  With a quickly receding appetite for debt, it is likely it will be accompanied by some form of tax increase.  The current ideas being floated include raising the income tax on individuals earning more than $400,000, expanding the estate tax’s reach, and implementing a higher capital-gains tax rate on individuals earning at least $1 million annually.  It could also raise the corporate tax rate to 28% from 21%, pare back tax preferences for pass-through businesses (such as LLCs or partnerships), and revise laws to prevent U.S. companies from shifting jobs and profits offshore.  Call me skeptical, but there has been talk of an infrastructure bill going all the way back to the Reagan administration.  I’ll believe it when I see it, and let’s hope it isn’t laden with pork barrel spending with little connection to infrastructure.  Yes, I know… who am I kidding?

In closing, I want to talk about an issue that isn’t being widely discussed but will be inevitable down the road.  The quick ascendancy of electric vehicles (EVs) appears to be reaching a tipping point.  It is likely that in the next five years, a not insignificant number of EVs will be on the road, and by next decade that number could equal or surpass those of internal combustion engine (ICE) cars.  This raises the question, how do states make up the shortfall in gasoline taxes in order to maintain and repair its roads?  The answer is both obvious and unpleasant.  Two states, Oregon and Utah, have already implemented a system to charge a per-mile fee with several other states running pilots to test technology and build public support.  Twelve states, including California, are currently working on new legislation.  Putting something like this on a national scale would involve tracking millions of vehicles.  Supporters are pushing for the quick adoption to maintain funding of the nation’s crumbling infrastructure (see there it is again), while opponents argue the shift could slow the adoption of electric vehicles.  What this means for taxes, privacy, and the wide-open road are anyone’s guess.  While I confess to embracing technology, I must admit this is one change I’m not sure I welcome.  Know you know.

Bruce J. Mason, MBA