Post-Pandemic Spending Could Defy the Fed

In recent weeks, some investors have grown more cautious, driving a modest resurgence in bond buying, with the 10-year Treasury yield slipping nearly 20 basis points to 1.6% since the end of the first quarter.

We believe that the Federal Reserve’s commitment to a narrative of “lower for longer” interest rates has helped to resurrect the so-called secular stagnation trade, in which investors overweight defensive, secular-growth mega-capitalization stocks vs. value, small-to-mid-cap and cyclical names.

We disagree with this defensive mindset and believe that its adherents are undervaluing the potential for a reservoir of excess savings and pent-up demand, combined with fiscal stimulus, to help boost the post-pandemic U.S. economy. 

One feature of the Fed’s stance, and that of many bond bulls, is based on the expectation that many consumers may save the bulk of their stimulus payments—or use it to pay down debt—rather than spend it. This view disregards how much the pandemic has impeded spending opportunities and the prospect for reopening to fuel a surge in consumer outlay that will help drive a hotter, but shorter, expansion. It also fails to account for the fact that today’s excess savings come from a mismatch between the timing of stimulus payments and the full reopening of the economy, which will eventually be resolved as pent-up demand materializes.

There are several reasons why we see this expansion unfolding differently than in prior business cycles. First, U.S. household savings are near historic highs. And cash coffers at S&P 500 companies—currently $2 trillion—are already at all-time highs. Balance sheet capacity is strong too, with household net worth at a staggering $130 trillion, up from $118 trillion a year ago, and S&P 500 debt-to-market-capitalization levels near historic lows. That means both consumers and companies have greater capacity to borrow and spend. Not only that, but these conditions exist at the beginning of a cycle, usually when balance sheets are at their weakest.

Will the pent-up demand materialize? We are already seeing some signs. Housing starts have soared to their best levels since 2006, indicating strong demand for homes, amid more remote-work opportunities and a move away from large urban centers. Meanwhile, among companies, capital-spending orders are running ahead of schedule, and investments in digitization—aimed at making contactless business practices permanent—are contributing to a semiconductor shortage. Shifting priorities around climate change, carbon neutrality and infrastructure investment are also likely to fuel spending.

The other factor is liquidity. Banks are well capitalized and ready to lend. Fed data show that, as of March 31, the big banks’ loan-to-deposit ratio was 54%, the lowest level in 36 years—even amid falling defaults and credit charge-offs and as banks move to absorb the loan-loss reserves that they originally set aside last year. As a result, we expect borrowing balances on commercial and industrial loans and consumer credit cards to starting growing in the coming months.

To be sure, these developments carry risks. Hotter economic growth may lead to boom-bust conditions and inflationary pressure. Investors should watch for excess savings to cycle into economic growth and corporate investment, including share repurchases and dividend hikes.

We suggest that investors take advantage of the recent bond market rebound to rebalance fixed-income allocations. Consider shifting into shorter-maturity bonds that are less sensitive to interest-rate swings while also increasing exposure to corporate bonds with better credit quality. 

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from April 26, “Awash in Cash”. Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this report.