Monthly Wrap: April 2021
While it wasn’t all smooth sailing for investments in April, markets closed largely higher as bond yields stabilised and reflation trade continued its course, explains George Lin.
Taken from the CBA Global Economic and Markets Research report in publications titled "International Economics: Selected Issues", first published on 23 April 2021.
President Biden announced the ‘American Jobs Plan’ (AJP) on 31 March 2021. The plan outlines $US2.28tn in spending across a range of sectors (chart 1) over eight years aimed at ‘rebuilding’ the US economy and improving competitiveness. The AJP comprises five streams.
We estimate that the commodity-intensive component of the spending plan is $US1.3tn (chart 2). The remaining $US1tn is only loosely linked to infrastructure and is closer to recurrent spending than investment.
In the US, the Congress – not the President – has authority to make laws on spending and taxation. The President has authority to accept or reject bills passed by Congress.
We see a solid chance Congress approves an infrastructure plan. The Congress has small Democrat majorities in both the House of Representatives and the Senate. Party discipline is much weaker in the US compared to Australia. This means members of Congress vote with the opposing party much more frequently than in Australia. We expect any legislation that is agreed will be passed using the ‘budget reconciliation’ process to avoid the requirement for 60 votes of support in the Senate.
Polls of voters show high support for increased spending on infrastructure. But the President’s plan could be changed materially because there is not majority support for his infrastructure plan (chart 3). Overall, we expect an infrastructure bill to pass Congress and be accepted by the President. But the plan that Congress passes may be quite different – and smaller – compared to the President’s plan.
To better understand the implications of a large increase in infrastructure spending it is useful to understand the cost structure of US infrastructure providers. Increased infrastructure spending by the US Federal government will ripple through the supply chain beyond infrastructure providers to many industries such as mining, manufacturing and various service providers.
We use the US ‘use’ table to reveal the purchases of three types of infrastructure providers, those that build: (i) power and communication structures; (ii) transportation structures, highways and streets; and (iii) educational and vocational structures. We estimate these three industries and their supply chains will directly benefit from around $US1.3tn in spending from the President’s plan.
The latest use table with enough detail covers 2012. Obviously, the data is older than we prefer. However, the cost structure of infrastructure providers appears to be stable over time. The cost structure in the 2012 use table is very similar to the previous use table for 2007.
The use table reveals that labour account for half of the direct costs of providing infrastructure (green segment in chart 4). Manufactures account for over one-third of infrastructure provider’s costs (red segment in chart 4). Some parts of manufacturing and professional services that supply infrastructure providers have a high labour cost component (chart 5). The upshot is labour costs probably account for around 60% of total costs of providing infrastructure throughout the supply chain.
Keen observers will notice that mining is not separately identified in chart 4 because it is part of the ‘rest’ of industries that contribute only 6% of infrastructure providers’ costs. Manufacturers of course use metals and energy to make the products they sell to infrastructure providers. Therefore, mining is probably a larger share of infrastructure provider’s costs.
We use our global input-output model to estimate how much mining output ends up in fixed investment such as equipment and structures. The model detail does not separately identify infrastructure investment from all other investment such as home and office construction, and equipment. Nevertheless, the results are informative. We estimate only 4-5% of US fixed investment is mining output (chart 6). The rest of the cost of providing fixed investment comprise labour and the output of other industries such as manufacturing. The bottom line is mining is not likely to be a major beneficiary of an increase in infrastructure spending.
As noted above, we consider around $US1.3tn will directly support infrastructure providers. The plan is proposed to last around eight years. On average, around $US160bn/yr (0.7% of projected 2021 US GDP) is proposed to be spent.
Such a plan will provide a material boost to the US economic recovery. We estimate more than 80% (0.6% of 2021 US GDP) of the infrastructure spending will be met by US production (chart 7). The remaining 20% will spill-over to increased foreign demand (‘RoW’ – rest of world in chart 7).
We note infrastructure projects, particularly new infrastructure, are complex. Projects are often delivered late with cost over-runs. The International Monetary Fund estimates it takes five years to prepare plus five years to implement infrastructure projects (chart 8). The upshot is spending is likely to be below the $US150bn/yr in the next few years as preparation hurdles are overcome.
The remaining $US1tn will also provide a material boost to the US economy. However, the spending is also likely to be spread over eight years and is likely to average around 0.5% of annual US GDP.
With 4-5% of US fixed investment directed to mining output, the impact of President Biden’s ‘American Jobs Plan’ on US commodity demand will be limited. The final form of the ‘American Jobs Plan’ is also likely look smaller than it does now once it passes through US Congress. That suggests an even more limited impact on US commodity demand.
There are a few commodities though that can tighten, especially if the decarbonisation elements of the infrastructure spending plan are kept. For example, the support for electric vehicles and electricity grids will boost demand for metals like copper, nickel and aluminium.
Around four times more copper is used in an electric vehicle compared to a regular internal combustion engine (ICE) automobile. Renewable power systems are also five times more copper intensive than conventional power systems. With a supply pipeline equivalent to only three years’ worth of demand, copper markets are at risk of tightening if decarbonisation trends gain more traction.
Nickel use is also set to increase as electric vehicle uptake is increased (chart 9). Nickel also stands to benefit as lithium-ion battery chemistries, particularly in the US and Europe, favour increased nickel intensities to improve energy density. Higher energy densities in batteries allow longer driving ranges for electric vehicles. Nickel markets are at risk of tightening too, especially the high-purity nickel that is used in batteries.
Apart from the magnitude of the spending, the impact of the Biden’s ‘American Jobs Plan’ on commodity markets will hinge on how long it takes for the infrastructure projects to be deployed. A longer timeframe, which is where the risks mostly lie, will spread demand and reduce the annual demand impulse.
The US commodity supply response to the ‘American Jobs Plan’ is also a crucial assumption. Our estimate that the US will look to supply ~80% of its raw material needs has a significant impact on commodity markets too. The impact on iron ore markets are particularly mitigated by this assumption. The US produces most of its steel via electric-arc furnaces (chart 10). These EAFs predominantly use scrap steel at the expense of iron ore and coking coal. Iron ore and coking coal markets are therefore less likely to tighten as US infrastructure projects are deployed.
President Biden’s plan to decarbonise the electric grid by 2035 also means that gas demand in the US power sector should eventually decline (chart 11). That may see US LNG exports rise even higher as weak domestic demand incentivises exports. That has the potential to weigh on LNG spot prices over the medium term. Around ~25% of Australia’s LNG exports are impacted by the LNG spot price. Most of Australia’s LNG exports are tied to the oil price via long-term contracts with Japanese, South Korean and Chinese utilities. A strong US electric vehicle uptake though could similarly see US oil demand fall in the medium term. Like LNG, that may see US oil exports rise, weighing on global oil price benchmarks.
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This information was first made available to CBA clients on 23 April 2021 in publications titled “International Economics – Selected Issues - Retail”.
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