Yellen’s statement on moderate interest rate hikes to prevent the economy from overheating has triggered sharp market swings. In an interview with The Atlantic Monthly on Monday, U.S. Treasury Secretary Yellen said, “Interest rates may have to rise somewhat in order to ensure that the economy does not overheat. Even though the increased fiscal spending is small compared to the total economy, it may still lead to a very modest rise in interest rates.” Following the announcement of this statement on Tuesday, May 4, U.S. stocks fell sharply, with the Nasdaq closing down 1.88% and the VIX volatility index rising 6.4%. In this regard, the market widely speculated that this time is Yellen in consultation with the Federal Reserve after the statement made, the purpose is to test the market reaction.
Yellen and the Fed cooperation to test the market is less likely, we believe that Yellen’s statement is mainly in response to the criticism of Biden’s economic stimulus plan within the Democratic Party. In the U.S. round of fiscal stimulus package, the size of the U.S. deficit rapidly expanded to $3.13 trillion in 2020, accounting for 14.91% of GDP, an expansion of 10.28 percentage points from the previous year. The total U.S. national debt is now over $28 trillion, up 21.4% from the beginning of 2020. Biden’s sixth round of the $1.9 trillion covid-19 bailout pushed the total fiscal stimulus to more than $5.6 trillion, making it the largest economic stimulus package in U.S. history. Under the pressure of rapidly climbing debt, I believe no finance minister will want to raise interest rates. At the same time, given the independence of the Federal Reserve, it is highly unlikely that Yellen will work with the Fed to test the market. There is currently a lot of disagreement within the Democratic Party over Biden’s stimulus plan, with more debate among party factions. While there is nothing wrong with increasing government spending to counter the impact of the epidemic, there are views that Biden’s stimulus plan is too aggressive and comes with risks that may lead to a rapid upward spiral of inflation, an overheated economy, damage to the interests of the poor, and an impact on the dollar and asset prices. Lawrence H. Summers, a representative of the Democrats on the right, said in an article in February this year that without new fiscal stimulus measures, the difference between actual output and potential output would fall from $50 billion to $20 billion per month. Such questions were also raised during the Obama administration, when Summers noted that the Obama stimulus package was about half the output gap, while the Biden administration’s new stimulus bill was about three times the output gap. He argues that the stimulus package should not be designed to threaten either inflation and financial stability or the ability to rebuild the economy through public investment. On this issue, we believe Yellen’s position is neutral. While expressing concern about the overheating of the economy, she also emphasized the short-term nature of rising inflation and argued that there is room for upward movement in overall asset prices and interest rates. Therefore, we think Yellen’s statement this time is likely to be a response to other Democrats to clarify her policy ideas.
We believe that U.S. inflation is short-term in nature and that supply-side issues are the main reason affecting the recent upward movement of inflation. The rise in raw material prices is not only disruptive to our inflation, but also one of the main reasons for the rapid upward movement of U.S. inflation. We believe that the supply-side problem is a stronger disturbance to U.S. inflation than fiscal stimulus, and is the main reason for the short-term upward movement of inflation. Prices of non-ferrous metals and agricultural products are rising rapidly due to the escalating problem of the spread of the epidemic in raw material exporting countries such as Chile and Brazil and the escalation of anti-epidemic measures such as border closures and work stoppages. Copper is critical to industries such as infrastructure and clean energy, and global demand for copper is expected to rise. According to the World Bureau of Metal Statistics (WBMS), the global copper market supply gap has risen 3.6 times to 1.391 million tons in 2020. LME copper has risen 13% from early April after market concerns about copper supply rose following the closure of the Chilean border in response to the outbreak. Meanwhile, economic growth in the U.S. is facing challenges from slowing population growth. The latest data from the CDC and the National Center for Health Statistics show that the number of newborns in the U.S. will be 3.6 million in 2020, a 4% contraction from 2019, and has declined for six consecutive years to a new low since 1979. With the drag of slowing population growth, the growth momentum of the U.S. economy may weaken. On balance, if supply-side issues are resolved, upward pressure on inflation will be reduced and inflation will be more moderate in the future. We still believe that the Federal Reserve will not change its current position and will not raise interest rates too quickly and withdraw from the asset purchase program. Whether the U.S. monetary policy will exit will have to wait until after the vaccine is widely inoculated and the outlook for economic recovery is clear. In this context, although in the short term, the dollar, U.S. 10-year Treasury maturity yields have room to move up, but in the long term there is no basis for rapid upward movement.