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Dow soared on upbeat earnings, retail sales, and signs of moderate BBB plan with a moderate tax hike

calendar 16/10/2021 - 19:01 UTC

Dow Future soared almost +500 points Friday on upbeat earnings and retail sales after another +527 points rally Thursday. Dow was also boosted by signs of a moderate BBB (Build Back Better) plan with a moderate tax hike. On Friday, Goldman Sachs beat forecasts after eight S&P 500 companies reported quarterly results with each topping estimates, led by Bank of America, Morgan Stanley, and Citigroup amid record profit from Wall Street and M&A activities.

On Friday, all focus was also on U.S. retail sales as consumer spending is the backbone of the U.S. economy. The U.S. Census Bureau flash estimate shows that retail sales in the U.S. clocked $625.416B in September against an upwardly revised $620.850B recorded in August and $548.856B in Sep’20; i.e. an increase of +0.7% sequentially and +13.9% yearly. The market expectation was a -0.2% sequential (m/m) fall in September amid PUA expiry and hurricane/weather disruption. The Sep’21 retail sales were boosted by almost all major groups except electronics & appliances stores and health & personal care products.

But elevated inflation is also a major contributor to upbeat retail sales. Almost 52% of U.S. retail sales come from motor vehicles, building materials, foods & beverages, transportation fuel (gasoline) and hotels & restaurants, which are under high inflation; also inflated headline retail sales figures to some extent.

Overall, U.S. retail sales are now up by more than +18% from 2020 average levels ($610.594B vs $516.919B) and almost +$100B up from Jan’20 (pre-COVID) levels, thanks to unprecedented COVID fiscal stimulus of almost $5T (grants under CARES Acts) and $4.5T Fed liquidity. But at the same time such fiscal stimulus/grants, robust wage growth causing higher demand, while supply bottlenecks and labor shortage causing lower supply, resulting in unprecedented inflation, out of control of both Fed and White House. Thus Fed is finding itself increasingly behind the curve-both inflation and bond yield (market borrowing costs). The US dollar is also increasingly losing its purchasing power amid rising inflation, which will inevitably slow the economy going forward.

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Sticky/elevated inflation is also affecting consumer sentiment. On Friday, the University of Michigan's (UM) consumer sentiment flash data shows that U.S. consumer confidence/sentiment slips to 71.4 in October from 72.8 in September, below market forecasts of 73.1. The gauge of current economic conditions dropped to 77.9 from 80.1 while the consumer expectations went down to 67.2 from 68.1. Meanwhile, inflation expectations for the year-ahead edged up to 4.8% from 4.6% while the 5-year outlook eased to 2.8% from 3%.

The UM said the Delta variant, supply chain shortages, and reduced labor force participation rates will continue to affect the pace of consumer spending into 2022. There is another, less tangible factor that has contributed to the slump in optimism: confidence in government economic policies has significantly declined during the past six months amid the U.S. debt ceiling drama.

The University of Michigan (UM) said:

Consumer sentiment has remained for the past three months at the lows first recorded in response to last year's shutdown of the economy. The Delta variant, supply chain shortages, and reduced labor force participation rates will continue to dim the pace of consumer spending into 2022. There is another, less tangible factor that has contributed to the slump in optimism: confidence in government economic policies has significantly declined during the past six months.

To be sure, the DC logjam, including the debates on the debt ceiling and the $3.5 trillion social infrastructure program did not help, but the staged drama was largely ignored by most consumers. Consumers in the past were more attentive to the debates about extending the debt ceiling, passing major spending programs, or the face-off at the "fiscal cliff" (which may again happen in December). Unlike past debates, just 3% of consumers mentioned these policy debates when asked about recent news they had heard. Consumers presumably thought that these policies were important, but they largely ignored the dire partisan claims of an ensuing calamity. Consumers have much more basic concerns over the policy.

The adage "never let a crisis go to waste" mirrors the range and scale of Biden's progressive proposals, but consumers see it as too risky a strategy. When asked about their confidence in economic policies, favorable evaluations fell to 19% in early October from Biden's honeymoon high of 31% in April; while unfavorable policy evaluations rose to 48% in early October from 32% in April. The decline in confidence in economic policies was recorded across all age, income, and education subgroups as well as among Democrats, Independents, and Republicans.

The recent divergence between U.S. consumer sentiment and spending may be a result of extended PUA, boosting U.S. retail sales. Inflation is now turning into a real headache for both Fed/Powell and White House/Biden. Such higher inflation is not seen by many Americans in their lifetime and it may affect Biden/Democrats in the Nov’22 mid-term election and Biden may lose his theoretical trifecta, which is going to affect policies. Biden admin is already divided over the need for a $3.5T human infra plan (Build Back Better-BBB) and tax hikes.

But on Friday, Dow was also boosted after a report of progress in BBB negotiation between Biden and Manchin. As a reminder, on 28th July, just before the U.S. Senate passed the bipartisan infra bill ($1.2T) with the active help of Manchin, the Senate Majority Leader Schumer and Manchin signed an agreement over BBB. Manchin mentioned several conditions for his support for the BBB; otherwise, he may not guarantee to support the same:

Agreement between Manchin and Schumer to start budget resolution dtd 28th July’21:

·         Topline: $1.5T

·         Corporate tax rate: 25% vs current 21% and Biden’s 28% proposal

·         Corporate minimum domestic tax rate: 15%

·         The top rate on personal tax: 39.6%

·         Capital gain tax rate: 28% (all-inclusive)

·         Elimination of carried interest

·         Discuss tax gaps, rebate rules and dynamic growth

·         Begin debate on reconciliation bill: no earlier than 1st Oct’21; i.e. from FY22

·         Funds in the new legislation (BBB) can’t be disbursed until All funding from COVID legislation and ARP has been spent and Fed ends QE

·         Need-based targeted social spending (families & healthcare) with no additional handouts or transfer payments (grants/PUA etc)

·         Various conditions to protect the interest of the fossil fuel industry during the transition process to green energy (Manchin’s West Virginia is a fossil fuel/mineral/coal-rich state)

·         Senator Manchin does not guarantee that he will vote for the final reconciliation legislation if it exceeds the conditions outlined in this agreement

·         Schumer wrote a note saying that he “will try to dissuade Joe on many of these.”

Later Manchin said: "I wasn't trying to be a fly in the ointment at all. I've never been. I've never been a liberal in any way shape or form. For them to get theirs, I guess elect more liberals. I'm not asking them to change. I'm willing to come from zero to $1.5 trillion. I don’t believe that we should turn our society into an entitlement society. I think we should still be a compassionate, rewarding society”.

Also, as chair of the Senate Energy Committee, the coal state West Virginia moderate Democrat Manchin said his committee has sole jurisdiction over any clean energy standard and requests ‘innovation not elimination’ of energy sources. He’s also demanding support for technologies that capture emissions from power plants and store them underground, known as carbon capture and sequestration. Further, Manchin wants assurances that fossil fuel subsidies won’t be repealed if tax credits for wind and solar power are included in the bill and ask that if tax credits are extended to electric vehicles, they also include hydrogen-powered vehicles.

On Friday Biden admitted that aspirational social spending plan of $3.5T needs to be pared down for the passage Biden said he hoped to approve some policies without 10 years of funding — a compromise pushed by House Speaker Pelosi that still faces skepticism from centrists led by Manchin. Biden added he wasn’t giving up on his proposal for two years of free community college:

“To be honest with you, we’re probably not going to get $3.5 trillion this year. We’re going to get something less than that. But I’m going to negotiate--- I’m going to get it done. Look, it’s clear that it’s not going to be $3.5 trillion. The question is how much of what is important is going to get into the legislation? I’m of the view that it’s important to establish a principle on a whole range of issues without guaranteeing we get the whole 10 years. What matters is we establish it. I don’t know of any major change in American public policy that occurred by a single piece of legislation… What happens is you pass the principle and you build on it. I doubt we’re going to get the entire funding for community colleges, but I’m not going to give up on community colleges as long as I’m president---“.

Senate Budget Committee Chairman Sanders was among the contingent that has said the $3.5T was already a compromise and they’re threatening to derail a Senate-passed $1.2T bipartisan infrastructure bill if too much is removed from the larger proposal. On Friday, Sanders, a known Progressive/Socialist blamed the media for Biden’s $3.5t BBB proposal lacking enough support: “There have been endless stories about the role of the president, the conflicts in the House and Senate, the opposition of two senators, the size of the bill, etc. – but very limited coverage of what the provisions of the bill are and the crises for working people that they address”.

On Friday, Sanders also tweeted:It is the working class of America that makes this country move. Not Wall Street stockbrokers. Not real estate speculators. Not hedge fund managers. Not billionaires. Not CEOs taking exorbitant compensation packages while cutting the benefits of workers. Workers have the power”.

Sanders is the core architect for Biden’s BBB proposal that called for free community school/colleges, subsidies for child care and family, sick leave, and generous government aid for home and community health care for seniors and people with disabilities. It also called for vast federal renewable energy projects, climate change research, and the enactment of new pollution fees. The BBB plan would extend a temporarily expanded child tax credit — from $2K to $3-3.6K for children under six — and would be paid for through corporate tax hikes and hikes on high personal income and through stricter IRS enforcement.

On Friday, Sanders penned an op-ed published in Manchin’s hometown paper. In his article, Sanders lays out how his proposed Medicare expansion and drug pricing reforms would help West Virginia, a historically poor state that is aided by many federal programs. Sanders also pointed out climate action, paid leave expansion and other programs in Biden’s BBB plan could face omission if Manchin insists on opposing it. Sanders also specifically targets Manchin and Sinema, who both oppose the $3.5T BBB number and are trying to slash it down. Sanders wrote:

“Poll after poll shows overwhelming support for this legislation. Yet, the political problem we face is that in a 50-50 Senate we need every Democratic senator to vote ‘yes.’ We now have only 48. Two Democratic senators remain in opposition, including Sen. Joe Manchin”.

In response, Manchin hit back Sanders, who is his political/ideological rival (North-South pole) in the Democrat Caucus. Manchin has said he supports a $1.5T BBB spending program, viewing that as a compromise position from $0T. But Sanders initially wanted $6T and therefore views his deal with centrist Warner at $3.5T as a concession. Manchin said he, Sinema and 50 other Republican Senators will oppose such $3.5T BBB plan:

“This isn’t the first time an out-of-stater has tried to tell West Virginians what is best for them despite having no relationship to our state. Congress should proceed with caution on any additional spending and I will not vote for a reckless expansion of government programs. No op-ed from a self-declared Independent socialist is going to change that---Millions of jobs are open, supply chains are strained and unavoidable inflation taxes are draining workers’ hard-earned wages as the price of gasoline and groceries continues to climb. Senator Sanders’ answer is to throw more money on an already overheated economy while 52 other Senators have grave concerns about this approach”.

Bottom line:

Biden’s Democratic Senate majority is dependent on the support of two independent Senators led by Sanders and King. Sanders was the Presidential nominee against Biden in the 2020 Primary election for Democrats. Now President Biden, more like a Liberal has to balance the socialistic aspirations of Sanders with Manchin’s realistic/Centrist approach. Biden is trying to kill Sanders's big deficit spending plan through ‘Manchin gun’.

In other words, Liberal Biden has to balance Progressive Sander’s wishes through Centrist Manchin in this political game. And Biden/Manchin will ensure a moderate BBB plan around $2.5T, middle path of Manchin’s $1.5T and Sanders’ $3.5T along with moderate corporate tax increase (25% against 28%) and capital gain tax of 28% without any retrospective effect. This will be ideal for Wall Street and thus Dow got an additional boost in the last two days apart from upbeat earnings and economic data.




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