How Biden’s Stimulus Plan May Affect the Economy, Stocks, and Interest Rates

Congressional Democrats are gearing up for a quick passage of President Joe Biden’s $1.9 trillion pandemic relief package, with a plan to vote as early as the week of Feb. 1. The party has majorities in both chambers of Congress, making it possible Biden could pass his plan.

Meanwhile, lawmakers, economists and investors have all raised questions about how the proposed stimulus could impact the economy, markets, and interest rates.

Some have warned the bill risks overheating the economy and stock market, given how it comes on the heels of a $900 billion second stimulus package that was signed into law in late December. Others argue that the bigger risk is not doing enough, especially given how bleak the outlook for jobs is in some industries. Here’s a deeper dive into the discussions.

Potential Impact on the Economy

Biden’s plan includes $1,400 stimulus checks per person, as well as a $400-a-week unemployment insurance supplement through September. Such measures, which would quickly put money directly into Americans’ pockets, should support the economy, according to experts.

The vast majority of economists in a Reuters poll conducted between Jan. 19-22, responded that the proposed plan will boost the economy significantly. Nearly 90% said the U.S. economy would reach its pre-COVID-19 level within a year, although some said that could happen even without the Biden package.

However, the economists also responded that it could take until 2024 for the unemployment rate to fall back to its pre-pandemic level. A January Labor Department report showed that U.S. payrolls fell in December, with employers shedding 140,000 jobs. The unemployment rate was at 6.7%. That compares to February 2020, when the effects of the coronavirus hadn’t yet hit the economy, and the jobless rate was at a half-century low of 3.5%.

Treasury Secretary Janet Yellen, who helped steer the U.S. out of the 2008 financial crisis in her prior roles at the Federal Reserve, has echoed Biden’s comments about the need to “act big” in order to avoid “long-term scarring” in the economy. Former Trump economic advisor Kevin Hassett has also said he broadly supports Biden’s $1.9 trillion rescue plan: “I think we need to be risk averse.”

Inflation Risk

At the same time, some have sounded the alarm on the possibility of inflation picking up suddenly, shocking consumers in the economy with rapid price increases.

One of the most prominent figures to warn about this has been Larry Summers of Harvard University, who was an adviser to President Barack Obama. He said that Biden’s stimulus plan would cause the economy to overheat, although more importantly, it would help those who have been hurt by the pandemic: “If we do anything approaching this, we are going to be managing the economy with the accelerator more on the floor that any time in peacetime history.”

Business publications have reported that several conditions could drive whether inflation returns.

First condition: the downturn is only temporary and the labor market rebounds within a year. This is what roughly happened after the 2008 financial crisis. In fact, consumer spending during a week in early January was down just 2.8% from a year earlier, according to research group Opportunity Insights. It’s mainly restaurants, transport and entertainment that have struggled.

Second: the Federal Reserve continues to keep monetary policy loose. Fed Chairman Jerome Powell has said the time to raise interest rates is “no time soon.”

Third: the stimulus checks Americans received haven’t yet made their way through the economy but could get spent immediately when the economy fully reopens. Americans have $1.6 trillion in excess savings, according to Fannie Mae, a government-backed mortgage firm.

Potential Impact on the Stock Market

Biden’s stimulus comes at a time when some investors have already been nervous about the stock market being overvalued. They point to frothy valuations of money-losing companies and amateur investors making speculating bets.

Meanwhile, other market experts say the U.S. equity market could rally for longer. They point to how the S&P 500 Index trades at 22 times earnings projected for the next year. That’s below the peak of 25 times seen during the internet bubble of the early 2000s.

Investor Jeremy Grantham warned in a television interview that the Biden relief package would further inflate a market bubble. Instead of being spent on capital spending and real production, some of the federal money would end up in the stock market, he said.

There could be repercussions in the stock market from other actions by Biden. On Jan. 25, he signed an executive order that will boost federal purchases of goods and services made by U.S. companies and workers. The measure could lift earnings and shares of American manufacturers.

Reflation Trade

Since the announcement of effective Covid-19 vaccines in November, some investors have been piling into the so-called reflation trade–betting on a return to growth in the U.S. economy.

Riskier assets tend to do better when people are putting on reflationary bets: companies with small-market caps and those in the cyclical sector such as banks and energy stocks. Investors will also see if industries that have been most affected by the pandemic, such as travel companies and restaurant groups, will also experience a rebound in their shares.

The chief economist of the International Monetary Fund said on Jan. 26 that Biden’s stimulus package could boost U.S. economic output by 5% over the next three years. However, there are risks to the reflation trade. Even if Biden’s proposed plan gets signed into law, the virus could get worse, prolonging weakness in the economy.

Potential Impact on Interest Rates

Government spending tends to push up Treasury yields because it signals more government borrowing and a larger supply of bonds. Such spending can also boost expectations for growth and inflation, making it more likely that the Fed will raise interest rates.

The bond market has changed its tune in recent weeks, potentially anticipating that another bout of debt issuance and higher inflation will pressure the Fed to halt its own monetary stimulus and potentially increase rates. Prices of U.S. Treasurys have dropped, with long-term yields rising to levels not seen since March 2020. Yields rise when bond prices fall.

Still, inflation skeptics argue that the extended period of little-to-no price growth that the U.S. has seen in the past decade will continue. They argue that demographics, technology, as well as anemic economic expansion since the 2008 financial crisis have all contributed to low inflation, making it likely Federal Reserve interest rates will continue to be low.

Mortgage Rates

The moves in the bond market have some speculating what this portends for the mortgage market. Massive stimulus packages such as Biden’s proposal tend to brighten the economic outlook, pushing investors to sell safer assets like Treasurys and causing yields to rise. Mortgage rates tend to move in the same direction as the yield on the 10-year Treasury.

Many housing industry professionals have predicted that mortgage rates will climb in 2021. The increase would come after 2020, when the average rate on a 30-year fixed mortgage dipped below the 3% mark, falling to its lowest level in almost 50 years of records.

Most pundits predict though that home borrowers will still be able to access ultra-low rates, perhaps around 3.5% or 4%. While that’s higher than the sub-3% rates some people enjoyed in 2020, home borrowers should put things into perspective and remember that in the early 1980s, the 30-year mortgage rate went above 18% as the Fed sought to tame runaway inflation.

While home borrowers may encounter slightly higher mortgage rates, they may also have access to greater jumbo loan credit, according to the Mortgage Bankers Association. An index for jumbo loan credit rose by 1.4% in December, after sliding for much of 2020.

The Takeaway

Biden has indicated that he’s open to negotiating elements of his $1.9 trillion relief package, signaling it’s possible that Congress works with him and approves a smaller stimulus bill. But even before taking that potential reduction into account, stimulus money from 2020 alone totals $3 trillion, putting politicians in uncharted territory when it comes to fiscal intervention in the economy.

Such measures could have long-lasting effects on the U.S. economy. Home borrowers may be incentivized to refinance before economic conditions and mortgage rates shift significantly. SoFi offers mortgages and mortgage refinancing with competitive rates as well as a fast and easy application.

SoFi Invest®