International Forecaster Weekly

THE CIRCUS IS BACK IN TOWN - Problem Is, It Never Left

Matt Phillips is right when he observes that “the debt ceiling circus has arrived in D.C.” and it’s not going away anytime soon.

He writes today that the closer the federal government gets to “stiffing creditors” and going into an unprecedented default, “the bigger the implications will be for the markets and the economy.”

As I wrote in Friday’s article, the government hit its $31.4 trillion debt limit last Thursday.

While that’s a big deal, it’s nothing compared to what will happen to financial markets if the government defaults sometime mid-year.

For now, it just means the Treasury Department has to start using "extraordinary measures" – like drawing down its cash balances and deferring contributions to government pension funds – to keep paying its bills.

Treasury Secretary Janet Yellen told Congress that her department can keep juggling payments at least until June.

Markets don't appear to be overly worried at this point. But just wait. As Phillips points out, the longer the debt ceiling drama plays out — and the closer the government comes to default — the crazier markets will get.

That's exactly what happened in the summer of 2011, when we last came perilously close to the Thelma & Louise Driving Over the Edge moment into the abyss.

That year, as the crisis got worse into July and early August, the S&P 500 plummeted 15% and credit spreads that determined costs for home mortgages and corporate borrowings surged.

That jump came as investors grew leery of lending in the face of growing risk and uncertainty.

On the other side, those who say they want to cut government debt levels will likely claim that the turmoil the debt fight raised over a decade ago was worth it – despite the U.S.’s lowered credit rating.

They point to the Budget Control Act of 2011 that resulted from that debt limit fight, which helped cut federal budget deficits in subsequent years (note that it hasn’t actually helped cut the national debt, an important distinction).

So, however it turns out, the fight over raising the debt ceiling and avoiding default is going to hang over the markets for a good chunk of the year. 

And, at least for investors, according to Phillips, “it's likely to be a bummer.”

Guest Writer | January 25, 2023

By Dave Allen for Discount Gold & Silver

Matt Phillips is right when he observes that “the debt ceiling circus has arrived in D.C.” and it’s not going away anytime soon.

He writes today that the closer the federal government gets to “stiffing creditors” and going into an unprecedented default, “the bigger the implications will be for the markets and the economy.”

As I wrote in Friday’s article, the government hit its $31.4 trillion debt limit last Thursday.

While that’s a big deal, it’s nothing compared to what will happen to financial markets if the government defaults sometime mid-year.

For now, it just means the Treasury Department has to start using "extraordinary measures" – like drawing down its cash balances and deferring contributions to government pension funds – to keep paying its bills.

Treasury Secretary Janet Yellen told Congress that her department can keep juggling payments at least until June.

Markets don't appear to be overly worried at this point. But just wait. As Phillips points out, the longer the debt ceiling drama plays out — and the closer the government comes to default — the crazier markets will get.

That's exactly what happened in the summer of 2011, when we last came perilously close to the Thelma & Louise Driving Over the Edge moment into the abyss.

That year, as the crisis got worse into July and early August, the S&P 500 plummeted 15% and credit spreads that determined costs for home mortgages and corporate borrowings surged.

That jump came as investors grew leery of lending in the face of growing risk and uncertainty.

On the other side, those who say they want to cut government debt levels will likely claim that the turmoil the debt fight raised over a decade ago was worth it – despite the U.S.’s lowered credit rating.

They point to the Budget Control Act of 2011 that resulted from that debt limit fight, which helped cut federal budget deficits in subsequent years (note that it hasn’t actually helped cut the national debt, an important distinction).

So, however it turns out, the fight over raising the debt ceiling and avoiding default is going to hang over the markets for a good chunk of the year. 

And, at least for investors, according to Phillips, “it's likely to be a bummer.”

Another Elephant in the Room

If the debt ceiling drama weren’t frustrating enough on its own, it’s simply frightening to think it will evolve side-by-side with the year-long bout to rein in inflation while hoping for the best in the labor market and with overall economic growth.

To that end, the U.S. housing market continued its extended slump.

As shown in the chart above, in December, the latest data on previously built (aka existing) homes showed an 11th straight monthly decline.

The median price for such homes — the vast majority of the market — fell 1.5% from the previous month's $367,000.

That's still up 18% from the previous year. But it's down 11% from the June peak.

And perhaps more importantly, the average American household is now considered "rent-burdened." 

Moody’s Analytics says there’s a record number of renters spending more than 30% of income on rent each month.

That’s 36% higher than 20 years ago, at the end of the 20th century, when the rate averaged a more sanguine 22%.

Emily Peck calls this “a painful surge for many,” at a time “when inflation (while on the decline) has driven up the cost of food and energy.”

Tom LaSalvia of Moody’s Analytics says, "The average American household continues to be squeezed. And it's having ramifications on quality of life."

He added that rents are sticky. “They aren't likely to climb much further.” But he says don't expect them to fall much from where they are now.

This Elephant Has Tusks

Courtenay Brown and Neil Irwin reflect back to the 2nd half of 2022, when Federal Reserve officials “had the tone of a stern parent punishing a wayward child.” 

“I know this is going to hurt, but it’s for your own good…”

But Brown and Irwin say something is different early in 2023 – with many of those same officials saying they can ward off high inflation without households experiencing too much pain.

In other words, get lost boring recession and bring on the soft landing!

Brown and Irwin believe the Fed will likely raise the Fed funds rates by just one quarter of a percentage point next Wednesday and is poised to “wind down” its rate hikes faster than expected…if “inflation cooperates.”

That sentiment is shared by 98.6% of Fed futures traders today. Yes, only 1.4% of them (including me!) believe rates will be hiked by 0.5% on February 1st.

The focus now, they suggest, is on whether recent progress with inflation proves lasting (and not transitory) and not causing more economic distress for its own sake.

Last Friday, Fed governor Christopher Waller told a crowd that while there are reasons to be cautious about the recent good news, "it is good news."

"Six months ago,” Waller said, “when inflation was escalating and economic output had flattened, I argued that a soft landing was still possible…without seriously damaging the labor market.”

"So far,” he added, “we have managed to do so, and I remain optimistic that this progress can continue.”

And in a speech last Thursday, Fed vice chair Lael Brainard argued that "wages do not appear to be driving inflation in a 1970s-style wage–price spiral." 

She noted that inflation-adjusted pay hikes for low-wage workers have been offset by a drop in real wages for higher earners.

She also suggested the spike in business profit margins that coincided with the inflation surge could reverse in coming months.

Brainard said, "The compression of these [price] markups as supply constraints ease, inventories rise, and demand cools could contribute to disinflationary pressures."

Is Another False Dawn on the Rise?

Yet, Fed policymakers are focused on the risk that low core inflation in the 4th quarter of 2022 could be a false dawn, like it was in the summer of 2021. Waller warned, "We do not want to be head-faked.”

Jeanna Smialek writes that many economists and Fed officials believe it will take years for price increases “to fall back to the 2% level that used to be typical.”

Others, she adds, mainly WallStreeters, see inflation “returning to the historically-low levels” that existed pre-pandemic.

Even if the Fed’s preferred Personal Consumption Expenditures index shows inflation having fallen to 5% annually in December from 5.5% in November, our fate still rests in the hands of the Fed.

As Smialek warns, if the Fed ends up slowing the economy too much and causes a recession, Americans will pay with their jobs.

But if historically high inflation continues to erode savings and wage gains, “that will also leave households worse off.”

Thus, the Fed could be stuck between a rock and a hard place. And the rest of us could be damned if they do, and damned if they don’t.

I used to love going to the circus when it came to town. Now, not so much.