Morgan Stanley
  • Thoughts on the Market Podcast
  • Aug 4, 2021

The Long and Winding Fiscal Road

With Michael Zezas
U.S. Public Policy Research for Investors


Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, August 4th, at 10:30 a.m. in New York.

We focus again this week on fiscal policy. As we've been arguing, the bipartisan infrastructure bill, which could get a vote in the Senate this week, is just the beginning of a larger fiscal process that we think will result in deficit expansion and, accordingly, support for above average economic growth in 2022 and higher U.S. Treasury yields at year end. But here's how we'll be tracking it in the coming weeks and months to see if we're right, or wrong.

The first thing we'll likely know is how much more money Congress is likely to spend in addition to its prior budget baseline. We already know there's good prospects for the bipartisan infrastructure package to pass this week or next and add $550B to that baseline. What's likely next is the Senate approving, along party lines, a budget resolution in the next week or so that enables its reconciliation plan. But that resolution only sets the potential amount of spending, it's not the final bill. Still, the dollar amount of this resolution plus the bipartisan infrastructure plan should equal the maximum top line on new spending. We think together they will total nearly $4T.

After that is when the real negotiation begins: the ‘pay fors’. Basically, what taxes or other revenue raisers can Democrats agree on to offset the extra $3.5T in spending? This is important because we need to know if this total fiscal package will be completely offset by revenues, or if, as we expect, it will result in deficit expansion in the early years, giving the economy and Treasury yields a fiscal boost. Expect this to play out publicly over the balance of the summer and into the fall, sometimes in statements by Senators, sometimes in background reports to the press. But we're not expecting concrete indications until the fall, when both the House and the Senate are back in session, digging in on all these issues.

So that means the next couple of months are a critical time. As listeners probably know at this point, our expectation is that Congress settles on allowing some deficit expansion as part of its funding strategy for this bill, largely to bridge the gap between Democratic moderates and progressives on how high to raise taxes. But should we learn, for example, that Democrats are instead agreeing to lower their spending ask, or perhaps that Democratic moderates are more willing to meet the White House's tax hike requests than they've currently stated, that could change things for us. Our deficit estimate could come down, and with it our colleagues’ expectation for the level of economic growth and treasury yields next year.

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The U.S. infrastructure bill is just the start of a larger fiscal process through year-end that may bring above average growth and higher U.S. Treasury yields.

In this Thoughts on the Market series, Michael Zezas offers perspective on how U.S. public policy affects equity and fixed income markets, including trade tensions, infrastructure and government policy. Listen to this week’s update.

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