In this week’s update – we will discuss two important questions. The first, how does one make sense of weak sentiment and activity data with rising equity markets and the second, how serious is the US debt ceiling. In the markets we saw inflows into global equities driven by stronger US Q4 2022 GDP growth. Global bonds also saw inflows; however, money market funds saw outflows. Continue reading for the full weekly market update.
Two main questions seem to be on investors’ minds: (1) how does one reconcile the weak sentiment and activity data with rising equity markets and (2) how serious is the US debt ceiling saga and will it result in a debt crisis?
1. On the first, we received a timely report (courtesy GS) that analysed survey data. It applied a very behavioural analysis to support a view that I have held for some time - one has to draw a distinction between what they define as Soft and Hard Current Activity data. They track this based on their own CAI (Current Activity Indicator). Soft data is riddled with gloomy sentiment. Surveys can – and are – flashing red for a variety of reasons which, when used to project forward, not surprisingly imply downside risk. Business surveys tend to understate growth because they are formed around negative sentiment. Don’t forget also, they are lagging indicators – they look in the past. While we caveat financial projections with the saying “past performance is no guide to the future”, unfortunately the same is not applied to behavioural analysis. It’s hard to shift a habit! By contrast, hard data tends to focus on objective and quantifiable fundamentals e.g. production, shipments and employment – and the latter are nothing like as bleak as the soft data components suggest.
Overlay this with an environment of debt ceiling worries (see later on), geopolitical risk and persistent economic worries (e.g. financial conditions) and you have the recipe for accentuating the divide between the two types of data. Look at the chart below which compares the performance of the two vs GDP projections:
There is quite a gulf between the two. If one takes the current business survey trackers (soft data) for both manufacturing (46.2) and services (51.1), this is consistent with subpar, negative GDP. Contrast that with hard data (consumer spend, CAPEX shipments, nonfarm payrolls) and it’s a different story. Overall, this is not an unusual phenomenon. This gap between the two goes back in time e.g. 2011/12 (US debt ceiling), 2013 (fiscal cliff), 2016 (shale bust), 2019 (trade war) and now fed tightening & recession fears. The opposite is also true i.e. growth can end up being overstated e.g. 2017/18 (tax cuts) and 2020/21 (covid stimulus & reopening)
2. Which moves on nicely to the second question around the US debt ceiling. The current debt ceiling is $31.4tn. So why does it matter if Congress fails to reach agreement on extending the debt limit? Because the Treasury is responsible for financing the economy’s day-to-day operations and expenses. It’s like your bank refusing to extend your overdraft! This is not the first time it has happened. As mentioned above, it has led to gaps opening up between soft and hard activity data. They are invariably politically driven – the Republican hard right want big cuts in government spending (a bad time to happen for the US economy) and both sides are digging their heels in. This has led to talk around a “potential “X” date” i.e. when everything comes to a head. The worst case scenario, IF the US Treasury takes no action, is default. Imagine how catastrophic that would be – the US government failing to meet its debt obligations?! It would be financial Armageddon! Various analysts have looked into when this possible “X” day might be – the answers fall in the range July to October with a consensus developing around August. There is something of a timeline as to how this might play out:
February: the Treasury will release a quarterly document setting out funding plans over the next three months.
March/April: the Congressional Budget Office (CBO) will issue new budget projections for 2023/24; Biden will reveal his 2024 budget request.
18th April: marks the deadline for federal income tax returns – the more collected, the longer the runway.
5th June: this marks the very earliest and worse-case “X” date – but generally accepted it will be later.
30th June: if Treasury makes it this far, it will receive approx. $145bn from the Civil Service Retirement and Disability Fund” which could/would be used to process payments. Normally, these proceeds would be reinvested.
July-October: This is considered to be the “X” date range. It would affect government payrolls, social security benefits and bond repayments.
Can Treasury do anything to stop this? It certainly has tools to slow it down and has already begun extraordinary cash management measures aimed at clawing back $500bn. This will only give a short extension. Other measures comprise:
On 24th Jan, it suspended daily reinvestments in the “G Fund” which had a balance of up to $300bn. This is normally reinvested in Treasury securities. It would have to make this good again.
It could dip into its Exchange Stabilisation Fund (some $210bn). It was set up during the great Depression and was last used during the pandemic.
It could suspend sales of State & Local Government Securities. This would save a total of just $30bn.
Issue more cash management bills – a very short term measure.
Suspend savings bonds – a very small measure.
Asset sales - such as gold and other holdings, a desperate measure that would send out a dangerous signal.
So an agreement is vital. From the above amounts, they can only extend the pain for a limited period of time. As with all the previous debt ceiling sagas, we would like to think a deal will be reached – albeit at the 11th hour and 59th minute. It will very likely drag on for months. What happens in the end will depend on which party benefits the most. Never a dull day in D.C.
For w/e 25th January, global equity funds saw inflows again (Refinitiv). It totalled $3.23 bn driven by stronger US Q4 2022 GDP growth. European funds received $3.15bn and Asia $1.36bn while the US saw outflows of -$1.14bn (Risk-On continues). The outflows were across sectoral (healthcare, industrials & financials). Government bonds saw inflows of $3.52bn and short/medium bond funds had inflows of $1.05bn. Global MM funds saw outflows of -$12.25bn.
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