President Joe Biden’s Budget Plus the Latest on Ukraine

April 2022 | By JT Taylor Global Macro Analysis Politics Domestic International Market Perspectives

Washington’s focus returns to Ukraine and the remnants of the Biden Agenda.

What You Need To Know

As the fall midterms loom closer, the immediate headline risk of President Biden’s 2023 budget will fade and re-emerge later this fall.
Included in Biden’s budget are tax provisions aimed at paying for elements of the original Build Back Better Plan, and we’re likely to see a scaled-back version of that initiative in the coming months.
The Russia-Ukraine conflict is unlikely to end any time soon, but we’re in the midst of a major inflection point that will shape the international environment for decades.

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Within a few months, lawmakers will shift into midterm campaign mode, effectively closing the window on the passage of major substantive legislation in this Congress.

With the limited legislative window, a few key items are considered “must pass:”

The budget and corresponding funding bills, particularly for defense amid geopolitical turmoil;
Senate confirmation of Supreme Court nominee Judge Ketanji Brown Jackson; and
Legislation to counter China and provide $52 billion to support domestic semiconductor manufacturing.

Biden’s Budget

With the release of the Biden Administration’s 2023 budget, it’s important to keep in mind that a president’s budget is an aspirational blueprint and won’t become the law of the land as submitted—but we can use it to glean priorities and direction on multiple policy fronts. This year’s submission is notable given the increase in both domestic and defense spending that reflect the political and geopolitical realities, risks, and challenges Washington faces.

The Bull and the Bullseye

The ink isn’t even dry on the $1.5 trillion 2022 budget compromise that passed Congress (six months late) in February, and President Joe Biden’s $1.65 trillion 2023 budget submission to Congress is already being targeted by Republicans and Democrats alike. With increases in both domestic ($769B) and defense ($813B) discretionary spending, as well as deficit-reduction measures, Biden’s pivot to the center hasn’t mollified his critics on Capitol Hill with one exception: Sen. Joe Manchin (D-WV) who continues to hold the wildcard when it comes to major budget-related pieces of legislation and should be favorably disposed to large chunks of the effort given the projected deficit reduction impact of approximately $1 trillion.

With an eye squarely on the fall midterms, Republicans are in no rush to support Biden’s budget proposal, banking on an expected takeover of one (if not both) houses of Congress. And for good reason: In the event they do regain the majority, their leverage over spending bills would increase significantly after November. Democrats would lose the slim margin under which they are currently operating, which would make bipartisan support critical to any budget deal being negotiated in Q1 2023.

While most Democrats support the social-spending aspects of the budget as well as the billionaire minimum-income tax, many on the far left have balked at the increase in defense spending coming off a 7% increase in 2022. We’re not sure this opposition will hold given the worsening crisis in Ukraine as well as other emerging global challenges.

Build Back Better 2.0

Although the new fiscal year is six months away, Biden is using his budget plan to outline the agenda he wants Congress to pass before then, including tax provisions aimed at paying for elements of the original Build Back Better (BBB). We’re likely to see a return of a scaled-back version of that initiative in the ballpark of $700-900 billion at some point in late April or May. This is where Sen. Manchin’s support will be critical.

We’ve previously mentioned several potential components of BBB 2.0: healthcare, climate, and energy provisions, as well as changes to drug pricing and the corporate minimum tax to offset spending. Again, we currently don’t foresee changes to capital gains or personal income-tax rates unless you happen to be in the top 0.01% in the US qualifying for the aforementioned billionaire’s tax—and even that prospect is slim.

Bottom Budget Line

While Washington’s attention may divert to the shiny new Biden budget bauble, the focus will quickly return to the next phase of spending through BBB 2.0 and the burgeoning war in Ukraine and its aftermath. There’s a long way to go before Congress puts pen to paper on fiscal spending for 2023, and the looming November election will impact that timeline and willingness to engage.

With the Russia-Ukraine conflict now in its second month, there are emerging signs that an accord can be reached but not until both leaders meet face to face.

The Pivot Back to Geopolitics

Geopolitical risk centered in Eastern Europe continues to loom large on and off Capitol Hill. Since the start of the conflict on February 24, there have been many false starts surrounding peace talks between Ukraine and Russia, and we’ve been skeptical given the red lines both President Volodymyr Zelensky and President Vladimir Putin have drawn (and, at present, those lines still don’t intersect). With the conflict now in its second month, there are emerging signs that an accord can be reached—but not until both leaders meet face to face with the red lines at least moving in the right direction. Absent this, the crisis may very well deteriorate or just grind on.

Russian Military Advances, Setbacks, and New Goals?

With Russian forces making steady progress toward reducing the critical Mariupol pocket and calls for the city to be evacuated, Russian military advances in Ukraine continue, but not without several setbacks. A Ukrainian loss of Mariupol would create a land bridge all the way to Crimea. Russia could start moving westward toward Odessa to seal off the Black Sea or mount an offensive toward the north, coming out of Crimea, to cut off Ukrainians fighting in the separatist regions (see FIGURE 1).

Kyiv was the political center of the country, and Putin’s aim was to set up a government in Ukraine that was amenable to orders from Moscow. But so far, the capital has held out as Ukrainian forces have continued to repel the Russians. Putin’s army appears to be changing its tactics and has shifted its strategic goals to the east in the Donbas region in addition to the south at Mariupol. Russian progress has been exceedingly slow, uneven, and, of course, deadly, but they continue to plod forward and bombard major cities with artillery, rockets, and air attacks.

FIGURE 1

Russian Advances in Ukraine

Data as of 3/29/22. Data Source: Soar.Earth.

Seeking Refuge

The rate of refugees leaving (~4 million) or being displaced internally (~6.5 million) is astonishing, with 80-90% of refugees women, children, and the elderly—that’s almost one quarter of the population. More people have fled their homes and at a faster rate than in any other conflict in recorded history. Putin may be using refugees as a weapon against NATO given that millions of refugees can be an enormous economic burden and strain on front-line countries (more than 2 million have fled to Poland) and that could encourage NATO to lean on Zelensky.

Unlike other conflicts we’ve witnessed over the decades, we believe Ukrainian refugees want to stay close to their homeland and don’t want to remain in their adopted host countries.

Some economists now predict the Russian economy could be half its size in the aftermath of the conflict.

Trading Places

More than half of the goods and services flowing into Russia prior to their invasion of Ukraine come from 46 or more countries that have now levied sanctions or trade restrictions, with the US and European Union leading the way. Some economists now predict the Russian economy could be half its size in the aftermath of the conflict.

It’s estimated that Russia and Ukraine account for 30% of the world’s wheat exports, 17% of corn, 32% of barley, and 75% of sunflower seed oil. But now, all that food is stuck, including 15% of the world’s fertilizer, which originates in Russia. As inflation continues in almost every corner of the economy, dark clouds remain on the horizon not just domestically, but in pockets of the world where food shortages could accelerate unrest. This is especially true in the Middle East and North Africa where countries such as Syria, Jordan, and Egypt are extremely vulnerable.

Putin’s Play

Our colleague and the former dean of the Army War College, Col. Jeffrey McCausland, has helped us shape our views since the inception of the invasion. He posits that Putin wants to go down in history with the likes of Peter the Great, Catherine the Great, Ivan the Terrible, and Nicolas I—as one of Russia’s great leaders. But he knows there’s no retirement home for old dictators. So, he must convince his fellow Russians that his strategies are successful. Russian propaganda is certainly depicting NATO and Ukraine as aggressors and pushing populism despite all evidence being to the contrary.

While there has been no large-scale domestic opposition to date, that could change if layers of Western sanctions hit the economy hard and the significant death toll on Russia’s military begins to set in.

McCausland uses an old Russian proverb to define Putin’s mentality, “If you dance with a bear, the bear decides when the dance is over.” Even if Putin backs down, his goals and strategy to influence Europe will continue.

How Does This End?

McCausland offers up four scenarios:

Confrontation – This could escalate to a full-fledged conflict between the US, NATO, and Russia, which would also increase the threat of nuclear weapons, a scenario which can’t be ignored.
Occupation – If the Russians were to defeat the Ukrainian army and take control of the territory, it could lead them into an insurgency.
A deal and possible frozen conflict? – The war could end in a cease-fire and a situation in which the conflict continues (on a lesser scale) for months to come.
Change in Moscow – Should a regime change in Russia occur, the nature of this conflict would also change.

Putin has accomplished something that Biden and recent past presidents haven’t been able to—uniting strong majorities on Capitol Hill. From sanctions and banning energy imports to ending preferred trade status for Russia and increasing defense spending, we’re betting on more action from both ends of Pennsylvania Avenue.

Talk to your financial professional to make sure your portfolio is prepared for whatever happens in Washington D.C.

The views and opinions expressed herein are those of the author, who is not affiliated with Hartford Funds. Hedgeye Potomac Research is not an affiliate or subsidiary of Hartford Funds.

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About The Author

JT Taylor

Senior Policy Analyst, Hedgeye Potomac Research