There are very few legislative processes that demand the American public's attention to the degree that the Debt Ceiling has this year. There is an old saying, "Sausage and legislation are never pleasant to see being made, but the product can be good." This year's debate fits this to a T. There has NEVER been a debt default, but this is classic media hype. It is clear that we are in a difficult situation here in the US. We have just experienced the most expansive spending ever seen in the history of the world. In two years, the US increased its debt more than it has in its entire history combined. Wrap your brain around that one! And this debate comes at the tail end of massive interest rate increases which are sure to decrease economic expansion. Both of which are not conducive to a strengthening of our overall economy and the US Dollar. But I digress. So, let's take a look at what we are seeing.
What does the chessboard look like?
In a non-party-specific fashion, this debate involved leaders from both sides of the aisle. On the Republican side, we have House Speaker McCarthy. Now remember, McCarthy had to really fight to become the Speaker. When McCarthy was fighting for votes to become Speaker, he agreed to a conservative demand that Freedom Caucus conservatives be appointed to the Rules Committee. If these conservatives were to oppose McCarthy in his Debt proposal it could be disastrous for McCarthy and the party. On the other side of the aisle, you have Biden. Biden's issue was that if he did not get approval for the Debt Ceiling to be extended until 2025, he'd be dealing with this again just before the 2024 election, which would likely be a disaster for the Democratic Party. Clearly, both sides had a lot to lose. So, a quasi-stalemate ensued (typical in party politics).
Who gets what and why?
Democrats were successful in securing a suspension of the debt ceiling past the next election cycle into 2025. As long as many social programs that are existent and fully funded at present aren't slashed, it is a win for them according to their voting constituency. This money is money that has been allocated but not yet spent, therefore no change to the current situation. The bill that Republicans passed slashed “future” government spending and increased the debt ceiling only until March 31, 2024.
Getting a two-year suspension was a high priority for the Democratic White House. What the Republicans did get was, Defense spending levels being kept, Veteran health programs being kept that were approved by the Democratic Congress last year, and the much-publicized work requirements. These work requirements decrease benefits to those that are not actively seeking work that is on social welfare, but it excluded and kept benefits for veterans and the homeless. It also froze non-defense spending to levels approved in the last fiscal year.
This was a long and challenging process, but it does give Speaker McCarthy accomplishments that range from limited spending caps to energy permitting reform (repeal of many of Biden's drilling restrictions), and some work requirements for Federal welfare programs. So where does the money come from that is needed? Money is simply removed from one program that is already funded and placed the money somewhere else. You surely don't expect them to accept less! The money primarily came from clawing back the exorbitant unspent Covid programs, restraint in spending in some social programs, and assistance in the energy space, just to name a few.
What is the effect on the financial markets?
So, ultimately what we are looking for is the effect that this agreement will have on the markets. I have taken the time to be a little more myopic on this shortened trading week. To begin with, we got some pretty strong labor numbers. According to the Fed, their focus is all about labor labor labor. This week’s reports did not do well for the hopeful end to the rate hikes. Once again, the reports we got today, June 2nd made zero sense unless the layers are pulled back a bit. Non-Farm Payrolls were expected to come in in up 195K, they came in up 339K. Wow, this seems really strong….. but wait, average hourly earnings fell and the Unemployment rate, which was expected to be down to 3.4% from 3.5% actually increased to 3.7%. These facts don’t correlate!!! Unless one looks at what is making up these numbers. To quote Jon Johnson of Investment House, “Household is weak, non-farms strong, reported layoffs continue rising. The math doesn’t work until you remember it is government math, specifically, political math where the government workers make up 70% of the result given as low as 30% of companies actually report the data. Thus, it is all make-believe and you want to scream at the Bloomberg and other financial station anchors that the reason the data does not compute is because it is made up to put a good light on the administration.” To validate this, this week we have seen the opposite of what would be expected, falling rates, the US Dollar has continued to strengthen.
This says to me that the world likes the fact that we could finally agree “in principle” to something across party lines. Gold has been quiet. The US stock market has begun exercising some strength. It appears that this could be because there is a major unknown now off the table and the financial markets can now focus on earnings and revenue growth without worrying about a default of US Debt.
The technology group through the ferocious AI ramp up has seemed to suck up many industries in hopes that they might be "more '' profitable because of increased efficiencies that immediate AI deployment to their business functions could provide. It is beginning to seem as though almost every company leader who makes public commentary must expound the virtues of AI in the forward functions of their companies or their stocks are being cut off at the knees.
The impact of AI is real, and it is coming to all industries at breakneck speed. AI is the next layer of the onion in technology. It will take time to see what the ultimate effect will be but suffice it to say that many companies are pulling funding from other internal programs to deploy it to their AI efforts for fear of being left behind by their competitors who are effectively employing AI. The Chairman of SalesForce was interviewed by Jim Cramer on MadMoney Wednesday afternoon and explained specifically that call centers that provide customer service at Gucci have been transformed into salespeople because of the speed with which AI allows them to deal with customer issues. This is but one cross-over that before had not even been considered.
The Debt Ceiling is a difficult pill for our economy to swallow. In reality, this worry about the US defaulting on its debt is a broken record. The US has yet to default on its debt due to a failure to raise the debt ceiling. Congress has already authorized the government's budget. The circus tends to get resolved at the last minute with both sides claiming victory as the mainstream media whips up worst-case scenarios that have never happened. One other issue is also guaranteed. The US will continue to print money in the coming years. The question is when, not if, a black swan hits, how much will the Fed be forced to print? In principle, it looks as if a deal to raise the debt ceiling has been reached. In consequence, the Treasury will be able to increase its General Account balance, or TGA as it is known, which will reduce liquidity substantially. Banks with sufficient reserves to buy newly issued Treasuries will do so, thus drawing monetary liquidity from the banking system and providing needed capital to the industry. On top of this, after last Friday's PCE report, Fed Futures now places odds on another 25-bps rate hike when they next meet in June and one 25 bps rate cut in Nov-2023 to bring the final target rate to 5% - 51/4% by the end of the year. Of course, this yearend forecast is data dependent so should inflation remain elevated due to supply chain and other issues, the Fed may be forced to hike more than once this year about July. As of the end of the first quarter of 2023, M2 (money supply) growth is down to -2.6% YoY, its largest decline since the Great Depression. But then, the Fed never printed so much money in such a short period of time due to the pandemic.
History is yet to be written, but we seem to be riding this most recent storm out, and as usual, US companies are resilient and resourceful. US workers are smart and for the most part highly motivated. As we enter summertime it will be interesting to see if many things stabilize and if the US Election cycle of rising equity markets into year-end holds to history's precedent. Wednesday I will continue with my normal weekly market commentary, but the Debt Ceiling, I believe, is an important enough issue that it should be given the respect of a Special Report.