Capital markets perspective: Kicking the can
Capital markets perspective: The can has been kicked
Capital markets perspective: The can has been kicked
If there is a can, consider it kicked.
On Friday the U.S. Senate officially gave its stamp of approval to a deal negotiated 24 hours earlier between representatives of House Speaker Kevin McCarthy and officials of the Biden Administration, effectively kicking the budgetary can down the road until 2025. The Senate vote was separated from what would have likely been a messy U.S. default by little more than a few hours on a Friday afternoon and a lazy Sspring weekend – not quite an 11th hour solution, but close.
In truth, markets never really seemed all that worried about the potential for default. Sure, there were a few weird spikes in short-term yields along the way, maybe a few volatile days of trading when it looked like negotiations had reached an impasse (and definitely lots of breathless reporting in the press throughout the “crisis”), but at the end of the day, equity markets, at least for their part, seemed mostly willing to take it all in stride. That could be because investors recognized it as little more than a political melodrama they had seen before, or perhaps because nobody really believed lawmakers would actually take us over the brink. I suppose that last part is kind of like living with the threat of nuclear war: the outcome so unpredictable and potentially awful that everyone just decided to trust that nobody was dumb enough to actually press the big red button.
Ultimately, the market’s trust proved appropriate, the partisan fire-setters from both sides of the aisle refrained from burning anything down, and the big red button went un-pushed. So we’re off the hook until January 2025, which, per agreement, is the next time the debt ceiling debate is likely to reach Defcon 4.
In the meantime, though, I suspect the coverage of The Great Debt Crisis of 2023 will now morph into something a little less salacious or exciting: for example, what does the negotiated deal mean for things like entitlement spending? Or, perhaps slightly less boring (and of more immediate interest to the economy at large), how much will the deal reduce the fiscal tailwinds that have so far helped support the post-pandemic recovery? According to the Congressional Budget Office, the answer to that question seems to be “roughly $1.3 trillion dollars over the next 10 years1,” which sounds like a lot until you consider two things: first, the Federal government will probably spend around $5.8 trillion dollars this year alone, making $1.3 trillion over 10 years feel like kind of a drop in the bucket, and second, the CBO’s estimate assumes that Congress will continue to abide by the deal for the next ten years, even though compliance with its spending caps is only enforceable for the next two. (Yeah, right.)
But with the economy still trying to decide whether or not it wants to slip into recession, even a modest reduction of the fiscal impulse that was at least partially responsible for keeping the economy’s head above water until now is probably a mild negative. Will it be enough to end the recessionary debate once and for all? No, probably not. But you can add it to the list of things currently arguing for slower economic growth in the very near future.
And make no mistake, that debate rages on. This week’s entry onto the “yep, we’re probably headed for recession” side of the ledger included an accelerating decline in manufacturing activity as evidenced by a steeper-than-expected drop in the Institute for Supply Management’s manufacturing index2 and a truly dismal Dallas Federal Reserve manufacturing report.3 (For this week’s brain-teaser, consider this mind-bender, included in the Dallas Fed’s report: “Perceptions of broader business conditions continued to worsen in May...(while) the outlook uncertainty index retreated to 13.4, a below-average reading.” Translated, what Texas-area manufacturers seem to be saying is that “we thought business conditions were worsening, and now we’re pretty much sure of it...”)
If you’ve been reading this kind of stuff regularly, you’ll probably recognize that similar sentiments have been appearing in other manufacturing surveys for months now. In fact, there seems to be little debate that the goods-producing sector of the U.S. economy might already be in the throes of recession. But unless and until the much-larger services sector weakens in tandem, it will be hard for the economists at the National Bureau of Economic Research to declare that the U.S. economy as a whole is shrinking quickly enough to constitute recession.
Besides, even all those depressed Dallas-area manufacturers are still willing to hire good candidates when they appear at the factory gate. (The employment component of the Dallas Fed survey actually advanced even as orders, output and sentiment tanked.) And Dallas’ factories are hardly alone in this, and the trend illustrates a phenomenon I’ve begun to call “panic hiring,” which shows little sign of relenting: ADP’s estimate4 and the Department of Labor’s guess about how many jobs the U.S. economy created last month were both well ahead of expectations5, and the number of job openings unexpectedly surged back above 10 million in April.6 So if the economy really is headed for recession, the labor market still hasn’t received the memo.
Confused? Of course you are – anyone who isn’t utterly perplexed by the current macroeconomic backdrop probably isn’t paying close enough attention. But as confusing as it may seem, it’s also not surprising: systems as large and complex as the U.S. economy rarely move in a straight line, and that’s doubly true when there are so many cross-currents pulling sentiment and economic activity in different directions. There’s also the question of timing about which areas of the economy slow first and which take longer to cool, a dynamic that Federal Reserve Chair Jerome Powell acknowledges every time he utters his now-famous catchphrase about the “long and variable lag”: housing activity typically slows first in a recession (check), followed by industrial output (check, at least as far as manufacturers are concerned), and finally employment (still waiting for that one...).
Economic Events, June 5-9
Monday: PMI/ISM services, factory orders
Tuesday: No planned economic releases; T-bill auction announcements Wednesday: Consumer credit, EIA inventories
Thursday: Wholesale inventories, weekly jobless claims
Friday: No planned economic releases
Eventually, though, either the economy will either begin to recover or the last of the dominoes will finally fall and we’ll have our answer as to whether Powell’s Fed has pulled off the impossible: a soft landing after an aggressive 5% of monetary tightening. But for those taking odds, I’d place that likelihood as somewhat more remote than Democrats and Republicans sitting down together and kicking the budgetary can even further down the road next time the debt debate appears on the horizon, just after the 2024 election season.
What to watch this week
It promises to be a very light week in terms of economic data. The highlight will be Monday’s twin Purchasing Managers' Index and Institute for Supply Management releases, which will once again test the service sector’s ability to sidestep the weakness that has pushed the manufacturing sector into contraction, if not outright recession. As mentioned above, it will be difficult for the economists at the NBER – the official arbiters of the business cycle – to consider the economy in recession unless the services sector cools significantly. Monday’s ISM and PMI releases will provide an update.
If the NBER is waiting for services sector activity to cool before declaring recession, it’s probably also waiting for labor markets to slow. As last week’s payroll data showed, we’re not there yet. On the other hand, one release from last week that didn’t get much attention but probably should have is the Challenger layoffs report, which showed a fairly significant increase in layoff activity. (In fact, layoff announcements are currently running roughly three times higher than the same period last year.7) So far that trend has yet to fully assert itself in the weekly jobless claims data that we get every Thursday, but at some point the two figures will have to reconcile. Tune in Thursday to see if this week represents the inflection point.
On Wednesday, the Fed will issue data regarding consumer credit trends for April. This release doesn’t normally get much attention, but consumers are increasingly relying on credit – particularly revolving credit – to finance spending as excess savings balances accumulated during the pandemic dwindle. Look to Wednesday’s release for hints about whether or not consumer finances are truly becoming stretched too thin.
Similarly, the Energy Information Administration’s weekly report on petroleum inventories is usually a big yawn for everyone except oil company executives and energy analysts. It’s becoming more relevant, though, particularly as OPEC becomes more proactive in its efforts to tinker with global supply to keep prices “stable” as demand threatens to slow amid slowing economic growth. Wednesday’s report may provide insight into how effective the cartel’s efforts will eventually be, making Wednesday’s report more interesting than it has been in the past, especially for those of us with a gas tank to fill.
Finally, one implication of the lifting of the debt ceiling last week is that the U.S. Treasury can suddenly start issuing debt again. Beginning this week, a glut of new supply is likely to hit markets, which analysts at Bank of America suspect will lift T- bill issuance to roughly seven times normal over the next six months.8 Tuesday will represent the first opportunity to test the market’s willingness to digest all that new paper when auction announcements for 4-, 8- and 16-week bills are made.
2 https://www.ismworld.org/supply-management-news-and-reports/reports/ism-report-on-business/pmi/may/ 3 https://www.dallasfed.org/research/surveys/tmos/2023/2305
7 https://www.challengergray.com/blog/may-2023-layoffs-jump-on-tech-retail-auto-ytd-hiring-lowest-since-2016 8 Bank of America, via Bloomberg (6/5/23)
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