The markets are in a bit of a holding pattern as we work closer to the debt ceiling showdown. Lots of guessing going on about the ultimate solution, but no concrete news as of yet. Meanwhile, a couple of economic reports point towards a gradual softening in both the economy and the inflation outlook.
Weekly unemployment claims hooked higher in the latest report. As you can see below, they are back up to levels last seen in 2017.
Also notable is an unfolding slowdown in wage growth. The Atlanta Fed’s wage tracker fell meaningfully this week.
Neither report is recessionary by any stretch, but both indicate a cooling in the economy. From both the Fed’s and the market’s perspective this is probably welcome.
Which Inflation Matters?
The other major report was the consumer price inflation (CPI) number. There’s never just one number when these things are released. You get a year-over-year number, a monthly change, core, headline, inflation excluding housing, and on and on and on. So generally, you can find something to tell any story in a plausible way.
The main data points were as follows:
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The monthly change increased from the previous month, both for the headline number and excluding food and energy. Not great.
- What drove the monthly change? Car prices and gasoline. Well, this isn’t so bad the thinking goes. Both are really volatile data series.
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The year-over-year change points to a continued slowdown in the rate of change. Headline is down to 4.9% from a high of 9.1%. Core prices are also trending lower.
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There’s still no let-up in rental inflation (about a third of the CPI report). However, the forward signs are that rental growth should slow meaningfully later this year if the data from Zillow is anything to go by.
All in all, no real shocks. Bond yields fell modestly on the inflation news, but were quickly reversed as the attention turned back to the debt ceiling issue.
X Date Approaches
The markets really haven’t reacted much to the debt ceiling negotiations between President Biden and House Speaker McCarthy. However, this may change soon.
Treasury Secretary Janet Yellen thinks the U.S. Treasury will run out of money around the beginning of June (the so-called X date) if Congress does not raise or suspend the debt limit. Now this doesn't mean that the Treasury will have no choice but to default. Over the last twelve months government revenues were $4.6 trillion and trailing twelve months interest payments have been $583.6 billion (chart).
The Treasury has plenty of revenue to cover the interest payments on its debts as long as it slashes other outlays. But of course, this is going to be painful. How long can the Treasury go if a portion of Federal workers are furloughed? That’s hard to say, but in the past, it’s been two-to-three months.
In 2011, the last time the debt ceiling issue became contentious, the markets really didn’t react until about 10 days before the X date. Stocks sold off, but counterintuitively, bonds rallied, as you can see below.
What pushed yields lower? The prospect of lower fiscal spending precipitating a recession played a part, as did the crisis in Europe at the time. Corporate bonds struggled, though. The chart below shows credit spreads on investment grade bonds. They increased significantly during the debt ceiling/downgrade period.
What should we expect this time around? Will we see a compromise soon, or a ‘kick-the-can’ solution that just postpones the whole thing until later this year or early next? It’s impossible to know of course.
For what it’s worth, though, investors had flocked into 1-month Treasury bills in April as they were thought to mature before the X-date. Yields fell precipitously as a result. However, lately they have started to avoid 1-month bills in favor or 3-month bills. The thinking here is that short-term bonds are more exposed to delayed payments now the X-date appears to be early in June.
But conversely, 3-month bonds are viewed as a safer bet because they are likely to mature after a resolution. But traders are betting on a resolution. After all, who wins the political game in a default scenario? Probably no one. Time will tell.
(Other) Charts We Found Interesting
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Lots of talk about a crisis in commercial real estate leading to a repeat of the 2007/2008 crisis. What’s different this time around? Commercial mortgages are a much smaller part of the economy than residential real estate.
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One dynamic of today’s housing market is a lack of supply. The reason is pretty straightforward – most current owners have a mortgage rate well below 4%.
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Money continues to leak out of the banking system and into money market funds and Treasury bonds.
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Could Portugal’s population fall by roughly 50% over the next 75 years?
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Interesting chart that highlights the disconnect between reality and the media’s portrayal.
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Lake Oroville in September 2021 and now.