Morgan Stanley
  • Thoughts on the Market Podcast
  • Mar 11, 2021

Markets and the Next Big Debate: Infrastructure

With Michael Zezas and Matt Hornbach


Michael Zezas: Welcome the Thoughts on the Market, I'm Michaels Zezas, Head of U.S. Public Policy Research and Municipal Strategy for Morgan Stanley.

Matthew Hornbach: And I'm Matt Hornbach, Global Head of Macro Strategy.

Michael Zezas: And on this edition of the podcast, we'll be talking about legislative debates in D.C. over fiscal stimulus and infrastructure and how fixed income markets may react to potential outcomes. It's Thursday, March 11th, at 11:00 a.m. in New York.

Michael Zezas: We want to talk about what we think is next in Washington, D.C., the next big legislative debate, and that's around infrastructure, the Build Back Better plan. And why we think this was going to be yet another round of fiscal expansion like the COVID relief bill and ultimately supportive for the economy and risk markets. But it's important to note that markets' interpretation of this policy could vacillate between being positive and negative, something that could mean that the bulk of the rise in interest rates for this year could already be behind us.

Michael Zezas: So Matt, that's why we wanted to talk to you today and start with this question. When it comes to the infrastructure plan, what do you need to know in order to gauge its impact on markets?

Matthew Hornbach: Well, Michael, the first thing I'd like to know is the overall size of the package. And I'm sure our economists would like to know that as well, because that will help them gauge the type of demand impulse that the economy will experience over the next five to 10 years. I also would like to know how much of this package will be financed through tax increases versus how much of the package will be financed through deficits. The deficit angle is an important one because it will help us determine how much Treasury issuance is likely to go up from here. As you know, Treasury issuance has already increased quite a bit over the past year. But if there's going to be another increase, investors will want to understand how big that will be. That will help us figure out how high Treasury yields might go from here, as we've recently increased our forecast for the 10 year Treasury yield to end this year at 1.7%.

Matthew Hornbach: But, Michael, how much of this package do you think will be financed by deficits versus taxes?

Michael Zezas: In short, anything in excess of about $500B or $600B of spending we think will need to be deficit financed. And that really comes down to the level of tax increase that can gain support in the Senate. There are 50 Democratic senators. You need every single one of them to sign on to any policy choice. That means they need to be in complete consensus on any and all tax increases. At this point, we have on record many of the more moderate members of the Senate Democratic caucus signing on to a much more modest list of tax increases that adds up to around $500B or $600B, far short of the $3T+ menu of tax increase items that the Biden administration has suggested could be used here. At the same time, most infrastructure spending plans start with a price tag of $1.5T, and in some cases, some proposals are $2T or $3T or more. So then the question is, would Democrats scope down the spending side to $500B or $600B or would they just go ahead and increase deficits to match their spending ambition? We think it's far more likely to be the latter.

Matthew Hornbach: So, Michael, why would the Democrats do that, won't they pay a big political price?

Michael Zezas: I think in this circumstance they'd actually reap a political benefit. So there's two things going on. The first is that survey data after survey data shows that voters are not particularly concerned about deficits right now, rightly or wrongly. And in fact, many of them have signaled that they would be willing to exchange an expanded deficit in order to get a policy priority they like, like expanding infrastructure spending or health care, for example. At the same time, you have the economic thought leaders advising the Democratic Party saying that deficits should not constrain the policy ambitions of the party. So whether you are on the progressive left and perhaps you're listening to modern monetary theorists or if you're more in the centrist wing of the party listening to traditional Keynesians. Well, Keynesians and MMTers disagree on many things. At the moment they do not disagree on deficit expansion. They both think that that is not a problem and should not constrain the spending ambition associated with Democratic policies.

Michael Zezas: But Matt, while we think this is going to end in the package that's largely deficit financed and more moderate on the tax hikes, Democrats have every incentive in the short term to speak as if they're going to fully tax finance this. This is what polls show is actually quite popular with many voters. So how much might that perception influence markets?

Matthew Hornbach: Well, Michael, given how optimistic markets have become about the growth outlook as a result of the last round of COVID relief, investors might be somewhat disappointed to find out that the infrastructure package that people are hoping will come through by the end of this year might not offer any additional fiscal impulse through the deficit channel. It will also have an impact on how investors think about the future of Treasury supply in that if taxes are raised to finance this next round of stimulus, supply won't go up anymore in the Treasury market. And that, in and of itself, will make it more difficult for Treasury yields to keep rising, certainly as quickly as they have been more recently.

Michael Zezas: So there's a situation then where the perception of what might happen could actually influence markets quite a bit more than what we think actually happens at the end of the day. And that sort of dampens risk enthusiasm.

Matthew Hornbach: So clearly, this perception versus reality idea that you're talking about, Michael, will be important to how investors end up putting their money to work throughout the course of this year. How confident are you that this package at the end of the day will be financed by a bigger deficit as opposed to higher taxes?

Michael Zezas: We're fairly confident that this will be the end game. And in fact, Matt, I think you have been one of the people within Morgan Stanley Research who helped me realize that the motivation here in the stated ambition when it comes to deficit expansion shouldn't be underappreciated. Our own forecasts of what would happen with COVID relief inched up over time from $3T to $3.5T and that bill ended up at $1.9T, largely based on the dynamics of the Democrats' motivation to be ambitious in scope in pushing the economy forward and not letting deficits hold them back. It's a point that you've underscored time and time again to me. I don't know why this time would be different. And in addition to this being part of the domestic agenda, it's also part of the foreign policy agenda for the Biden administration. Their planned engagement with China includes a strategy of domestic investment to boost the economy to increase leverage for future deliberations around labor standards, environmental standards, and a whole host of other issues. So one message we plan to be consistent with while this debate is unfolding, and we think it will take most of the year to unfold, is that Democrats are highly motivated to get a deal like this done. We don't think deficit expansion will get in the way. And so as a consequence, you can get a big plan and not be constrained by the limited amount of taxes that can actually get 50 votes in the Senate.

Michael Zezas: Matt, as always, thanks for taking the time to talk with me.

Matthew Hornbach: Great speaking with you, Michael.

Michael Zezas: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show. 

Conversations around the “Build Back Better” U.S. infrastructure plan are ramping up. What do investors need to know about its potential impact on markets?

Thoughts on the Market is also available as a podcast on Apple Podcasts, Spotify, Google Play and other major podcast platforms. In addition, the most recent episode is available on Amazon's Alexa. Just ask Alexa to "Enable Morgan Stanley" or to "Add Morgan Stanley to my Flash Briefing."

For more about our Alexa skill, visit

For more Ideas, visit