Is the Federal Reserve’s monetary policy losing out to inflationary pressures? While supply chain costs have long been taken out of the inflation forecast, demand pressures have been stronger than hoped for by the Fed. One area of demand is the labor markets. While the Federal Reserve has a dual mandate to keep prices stable and maximize employment, the shortage of workers is adding to demand-pull inflation as wages are a large input cost in a service economy. As employment remains strong, they have room to raise rates, but if strong employment is a significant cause of price pressures, they may decide to keep the increases coming.
Background
The number of new jobs unfilled increased last month as US job openings rose unexpectedly in April. The total job openings stood at 10.1 million. Make no mistake, the members of the Fed trying to steer this huge economic ship would like to see everyone working. However, with the Bureau of Labor Statistics (BLS) reporting “unemployed persons” at 5.7 million in April as compared to 10.1 million job openings, creates far more demand than there are people to fill the positions. Those with the right skills will find their worth has climbed as they get bid up by employers that are still financially better off hiring more expensive talent rather than doing without.
This causes wage inflation as these increased business costs work their way down into the final cost of goods and services we consume, as inflation.
Where We’re At
The 10.1 million job openings employers posted is an increase from the 9.7 million in the prior month. It is also the most since January 2023. In contrast, economists had expected vacancies to slip below 9.5 million. The increase and big miss by economists’ forecasting increases in job opportunities is a clear sign of strength in the nation’s labor market. This complicates Chair Jerome Powell’s position, along with other Fed members.
It isn’t popular to try to crush demand for new employees, but rising consumer costs at more than twice the Fed’s target will be viewed as too much.
The Fed says that it is data driven, this data is unsettling for those hoping for a pause or pivot.
The Investment Climate
These numbers and other strong economic numbers that were reported in April, create some uncertainty for investors as most would prefer to see the Fed stimulating rather than tightening conditions.
But the market has been resilient, despite the Feds’ resolve. The Fed has raised its benchmark interest rate ten times in the last 14 months. Yet jobs remain unfilled, and the stock market has gained quite a bit of ground in 2023. The concern has been that the Fed may overdo it and cause a recession. While even the Fed Chair admitted this is a risk he is willing to take, he also added that it is easier to start a stalled economy than it is to reel one in and the inflation that goes along with expansion.
So the strong labor market (along with other recent data releases) provides room for the Fed to tighten as there are still nearly two jobs for every job seeker. Additional tightening will eventually have the effect of simmering inflation to a more tolerable temperature. If the Fed overdoes it on the brake pedal, according to Powell, he knows where the gas pedal is.
The Holiday Shortened Trading Week Started with Positive Market News
It’s a four-day trading week in the US as the calendar changes from May to June. The US stock and bond markets will open on Tuesday knowing a government debt default is now likely averted as President Biden and House Speaker McCarthy reached an agreement Sunday on a deal to raise the nation’s debt ceiling. They have ensured the citizenry they have enough support in Congress to pass the measure this coming week. As far as economic reports, jobs and the labor market will be in the spotlight.
The market is focused on the labor market because Fed policymakers are paying attention to jobs numbers to determine if conditions are so strong they may indicate wage inflation or if they weakened and not strong enough to withstand another rate hike at the June 13-14 FOMC meeting.
Tuesday 5/30
• 9:00 AM ET, FHFA House Price Index. While interest rates have risen, housing prices have been flat to up. Continued demand caused prices to increase by .5% in February, it is expected prices rose again in March by a .3%.
• 10:00 AM ET, the Consumer Confidence index has been sinking and is expected to sink further in May to 100.0 from April’s 101.3. If you recall, April was much weaker than expected, reflecting a sharp decline in job and income expectations.
• 1:00 PM ET, Thomas Barkin is the CEO of the Richmond Federal Reserve district. In light of the PCE inflation indicator late last week and statements by Fed Chair Powell the Friday before, insight into thinking from FOMC members could move market sentiment.
Wednesday 5/31
• 8:50 AM ET, Susan Collins is the CEO of the Richmond Federal Reserve District. Comments by Fed district CEOs may get heightened attention this week as the market looks for clues as to what monetary policy changes may occur from the FOMC meeting in two weeks.
• 9:45 AM ET, The Chicago PMI is expected to fall in May to 47.0 versus 48.6 in April which was the eighth straight month of sub-50 contraction. Above 50 indicates economic expansion, and below 50 reflects a receding economy.
• 10:00 AM ET, Job Openings and Labor Turnover (JOLTS) have been declining. Forecasters put April’s openings at 9.35 million.
• 1:30 PM ET, Patrick Harker is the CEO of the Federal Reserve Bank of Philadelphia. He will be speaking.
• 2:00 PM ET, If volatility sets in for the last two hours of trading on Wednesday, it may be because the Fed’s Beige Book is released. This report outlines the economic conditions in each of the Federal Reserve Districts. The FOMC uses the contents as a basis for its decision-making.
• 3:00 PM ET, Farm Prices may not be the most awaited for inflation indicator, but it is important as it is a leading inflation indicator. Agricultural prices for April are expected to have risen by 1.3% month-over-month. These increases will work their way into the Producer Price Index (PPI) and the Consumer Price Index (CPI).
Thursday 6/1
• 8:30 AM ET, Jobless claims for the May 27 week are expected to come in at 235,000 versus 229,000 in the May 20 week, which was lower than expected but followed 248,000 in the prior week.•
• 8:30 AM ET, Released will be the second estimate for first-quarter Nonfarm Productivity. It is expected to remain the same as the first estimate, at minus 2.7 percent.
• 10:00 AM ET, The Institute for Supply Management (ISM) Manufacturing Index has been contracting over the last six months. May’s consensus is 47.0 versus April’s 47.1.
• 11:00 AM ET, The Energy Information Administration’s weekly update on petroleum inventories in the US is expected to show a decline of 12.5 million barrels.
• 1:00 PM ET, Patrick Harker is the CEO of the Federal Reserve Bank of Philadelphia. He will be speaking.
• 4:30 PM ET, The Fed’s Balance Sheet report tells unveils if the Fed has been on track with monetary policy initiatives like quantitative Tightening (QT) and if the troubled bank outlets are getting more or less use. Obviously, this has been getting much more scrutiny by investors.
Friday 6/2
• 8:30 AM ET, The Employment Situation report is supposed to show a 180,000 rise is the call for nonfarm payroll growth in May versus 253,000 in April. Average hourly earnings in May are expected to rise 0.3 percent on the month for a year-over-year rate of 4.4 percent; these would compare with 0.5 and 4.4 percent in April, which were higher than expected. May’s unemployment rate is expected to edge higher to 3.5 percent versus April’s 3.4 percent, which was two-tenths lower than expected.
What Else
Look for a vote on the debt ceiling that is likely to pass both houses of Congress and be signed into law quickly this week.
Artificial intelligence, or AI, has been in the news at an escalating pace. While most agree it can make life better, there are also fears that if not governed, it can cause devastating problems. The White House is asking for input and comments before 5pm July 7. Get more information here.
On Tuesday May 30th and Wednesday May 31st, Tonix Pharmaceutical Holdings will be in South Florida presenting to investors as part of our Meet the Management Series. If you’d like to attend one of these roadshows, presented by Senior Management of Tonix, go here for more information.
Fitch Has Placed the United States and Some of its Debt on Credit Watch
What does it mean that rating agency Fitch has put the US debt on credit watch?
According to Fitch Ratings, a rating service that is one of the top three Nationally Recognized Statistical Rating Agencies (NRSRO), has placed the United States AAA Long-Term, Issuer Default Rating (IDR) on rating watch and at risk of a downgrade. The primary reason for the rating agency warning is the apparent standstill of negotiations related to the US borrowing limit along with the approaching day that the US may not be able to refinance the interest portion of approaching US Treasury Bills (T-Bills), US Treasury Notes (T-Notes), and US Treasury Bonds (T-Bonds).
Implications
When a top credit rating agency places a country’s debt on credit watch, it means that the agency is considering lowering that country’s credit rating if conditions remain unchanged or worsen. This would have a number of negative consequences for the country, and could negatively impact those that operate within its economy, this could include:
Higher interest rates on government borrowing
Higher rates on corporate debt priced off of US Treasuries
Higher mortgage rates spread to US Treasuries
A decline in the value of the country’s currency
Increased difficulty in attracting foreign investment
A downgrade of the US government credit rating below AAA would be a major event with far-reaching consequences above and beyond the immediate impacts bullet-pointed above.
Wording of the Fitch Ratings Warning
Rating agencies like Fitch, Moody’s, and S&P are private companies. Debt issuers pay to have their debt issues rated to provide investors with information and a framework of value. These rating agencies or NRSROs are somewhat akin to providers of equity research to stock market participants via company-sponsored research.
Some of the main categories listed by Fitch titled, KEY RATING DRIVERS, are “Debt Ceiling Brinkmanship”, “Debt Limit Reached”, “X-Date Approaching”, “Debt Default Rating Implication”, “Potential Post Default Ratings”, and “High and Rising Public Debt Burden”.
The concern with debt ceiling brinkmanship according to Fitch is the “increased political partisanship that is hindering reaching a resolution to raise or suspend the debt limit despite the fast-approaching x-date (when the U.S. Treasury exhausts its cash position and capacity for extraordinary measures without incurring new debt).”
Fitch’s warning indicates it still expects a resolution to the debt limit before the x-date. However, it believes risks have risen that the debt limit will not be raised or suspended before the x-date and that the government could begin to miss payments on some of its obligations.
Fitch pointed out that the US reached its $31.4 trillion debt ceiling on Jan. 19, 2023. While the US Treasury has taken what Janet Yellen called “extraordinary measures” she also expects the measures could be exhausted as early as June 1, 2023. The cash balance of the Treasury reached USD76.5 billion as of May 23, and sizeable payments are due June 1-2.
The x-date has been defined as the day the US can’t meet its obligations without borrowing above the current Congressional debt limit. Failure to reach a deal “to raise or suspend the debt limit by the x-date would be a negative signal of the broader governance and willingness of the U.S. to honor its obligations in a timely fashion,” Fitch warned. The rating agency indicated this “would be unlikely to be consistent with a ‘AAA’ rating”
Fitch also addressed the 14th amendment discussions and other unconventional solutions, “avoiding default by non-conventional means such as minting a trillion-dollar coin or invoking the 14th amendment is unlikely to be consistent with a ‘AAA’ rating and could also be subject to legal challenges,” Fitch advised.
The debt default rating warning comes from basic understanding of the role of a rating agency. However, Fitch did offer an opinion on the likelihood. “We believe that failing to make full and timely payments on debt securities is less likely than reaching the x-date, and is a very low probability event.
If a default did occur, Fitch indicated it would be more than one level adjustment to some debt affected. Fitch’s sovereign rating criteria would lead it to downgrade the sovereign rating (IDR) to Restricted Default (RD). Actual affected securities would be downgraded to ‘D’. Additionally, other LT debt securities with payments due within 30 days could be expected to be downgraded to ‘CCC’, and ST T-Bills maturing within the following 30 days could be expected to be downgraded to ‘C’.
“Other debt securities with payments due beyond 30 days would likely be downgraded to the expected post-default rating of the IDR,” Fitch wrote.
The US has a high and rising public debt burden, according to the rating agency. It points out that government debt fell to 112.5% of GDP at year-end 2022 (compared to 36.1% for the ‘AAA’ median). It peaked during the pandemic at 122.3%. Fitch forecasts debt to increase to 117% by end-2024. Debt dynamics under the baseline Congressional Budget Office (CBO) assumptions project that the ratio of federal debt held by the public to GDP will approach 119% within a decade under the current policy setting, a rise of over 20 pp. Fitch also recognizes the added cost of financing, adding, “interest rates have risen significantly over the last year with the 10-year Treasury yield at close to 3.7% (compared to 2.8% a year ago).”
Take Away
The decision to put a country’s debt on credit watch is not made lightly. One company announcement such as this can have an impact felt across the globe. It’s important for them to get this right. NRSROs typically would only put a sovereign nation, especially the US, where its debt is often called “the risk free rate,” and the US dollar serves as fiat currency. Firch did this because they view it as responsible and in line with what securities analysts and the rating services they work for are expected to watch out for.
In the current case of the United States debt ratings, the main concern is the political gridlock in Washington, which has made it difficult to reach an agreement on raising the debt ceiling. If the debt ceiling is not raised, the United States will eventually run out of money to pay its bills, which would trigger a default. Fitch would be embarrassed (and arguably irresponsible) if they maintained a AAA rating just one week before the US Treasury Secretary indicated the nation couldn’t roll its debt.
Federal Open Market Committee Minutes Reveal Uncertainty
The Federal Reserve released the minutes of its last Federal Open Market Committee (FOMC) meeting. They show the Fed, as a whole, at the May 2-3 meeting as less than clear as to the near-term direction of monetary policy. The U.S. central bank officials are best described as believing they need to be nimble and react, keeping their options open rather than have a plan to continue raising interest rates or hold them steady after future meetings.
Fed officials remained concerned about inflation. Conversations and debates centered on the impact of tighter financial conditions and the degree of lag with which monetary policy would have an impact. According to the meeting minutes, the expected lag could mean their tightening campaign is nearly finished.
This release provided long-awaited insight and shed a modicum of light on how seriously Fed officials were considering changing course or holding interest rates steady when they met last month.
Actual Decision
Federal Reserve officials moved unanimously to raise interest rates at the central bank’s meeting on monetary policy in May despite significant debate at the time over whether pausing tightening efforts would instead be the more prudent move.
The minutes from the Fed’s May 2-3 meeting show concerns and offer clues as to what is important to various factions of the FOMC.
Key Language in Minutes
Banking
“Participants noted that risks associated with the recent banking stress had led them to raise their already high assessment of uncertainty around their economic outlooks. Participants judged that risks to the outlook for economic activity were weighted to the downside, although a few noted the risks were two-sided.”
In their discussion, various participants commented on developments in banking, noting that the banking system was sound and resilient. They also patted themselves on the back, saying that, “actions taken by the Federal Reserve in coordination with other government agencies had served to calm conditions in that sector, but that stresses remained.”
Some participants noted that the banking sector was well-capitalized overall. The belief is that “the most significant issues in the banking system appeared to be limited to a small number of banks with poor risk-management practices or substantial exposure to specific vulnerabilities.”
U.S. Debt Ceiling
“Some participants also noted concerns that the statutory limit on federal debt might not be raised in a timely manner, threatening significant disruptions to the financial system and tighter financial conditions that weaken the economy.”
Inflation
“Regarding risks to inflation, participants cited the possibility that price pressures could prove more persistent than anticipated because of, for example, stronger-than-expected consumer spending and a tight labor market, especially if the effect of bank stress on economic activity proved modest.”
A few members felt further tightening could bring supply and demand imbalances more in line and reduce inflation pressures.
“Some participants cited the possibility that further tightening of credit conditions could slow household spending and reduce business investment and hiring, all of which would support the ongoing rebalancing of supply and demand in product and labor markets and reduce inflation pressures.”
Lag of Policy on Economy
A number of members saw evidence that policy was on track to rebalance price pressures and having its desired effect.
“In discussing the policy outlook, participants generally agreed that in light of the lagged effects of cumulative tightening in monetary policy and the potential effects on the economy of a further tightening in credit conditions, the extent to which additional increases in the target range may be appropriate after this meeting had become less certain.”
“Participants agreed that it would be important to closely monitor incoming information and assess the implications for monetary policy.”
There are two factors that the FOMC minutes noted would be determinants to whether additional policy actions would be needed, they are:
“…the degree and timing with which cumulative policy tightening restrained economic activity and reduced inflation, with some participants commenting that they saw evidence that the past years’ tightening was beginning to have its intended effect.”
“… the degree to which tighter credit conditions for households and businesses resulting from events in the banking sector would weigh on activity and reduce inflation, which participants agreed was very uncertain.”
“Some participants commented that, based on their expectations that progress in returning inflation to 2 percent could continue to be unacceptably slow, additional policy firming would likely be warranted at future meetings.”
“Several participants noted that if the economy evolved along the lines of their current outlooks, then further policy firming after this meeting may not be necessary.”
“Almost all participants stated that, with inflation still well above the Committee’s longer-run goal and the labor market remaining tight, upside risks to the inflation outlook remained a key factor shaping the policy outlook. A few participants noted that they also saw some downside risks to inflation.”
Uncertainty
Some participants commented at the meeting that they, “saw evidence that the past years’ tightening was beginning to have its intended effect.”
The members seemed to not have a handle on the impact of the health of the banking industry’s impact, the minutes read, “the degree to which tighter credit conditions for households and businesses resulting from events in the banking sector would weigh on activity and reduce inflation, which participants agreed was very uncertain.”
Take Away
The path forward for monetary policy is, as the Federal Reserve has continually stated, data dependent. The clarity of trends of the data is unclear in part because of any expected lag, the health of banking, and the stickiness of inflation.
Reliable Data, Not Emotions, are Pointing to a Growing U.S. Economy
In roughly one month, we will be halfway through 2023. While many point to the Fed’s pace of tightening and the downward sloping yield curve, as a reason to run around like Chicken Little warning of a coming recession, a fresh read of the economic tea leaves tells a different story. Just today, May 23, the PMI Output Index (PMI) rose to its highest reading in over a year. Home sales figures were also reported to show that new homes in May sold at the highest rate in over a year. These are both reliable leading indicators that point to growth in both services and manufacturing.
U.S. Composite PMI Output Index
Business activity in the U.S. increased to a 13-month high in May due in large part to strong growth in the services sector. This is a reliable indication that economic expansion has growing momentum. Despite the negative talk of those that are concerned that the Fed has lifted interest rates closer to historical norms and that the yield curve is still inverted, in part due to Covid era Fed yield-curve-control, the numbers suggest less caution might be warranted.
S&P Global said on Tuesday (May 23) its flash U.S. Composite PMI Output Index, which tracks the manufacturing and services sectors, rose to a reading of 54.5 this month. It indicates the highest level since April 2022 and is up from a reading of 53.4 in April. A reading above 50 indicates growth, this is the fourth consecutive month it has been above 50. The consensus among economists was only 52.6.
Home Sales
One sector that is directly impacted by interest rates is real estate. However, new home sales rose in April, this is a clear sign that prospective buyers are making deals with builders.
New homes in April were sold at a seasonally-adjusted annual rate of 683,000, Its the highest rate since March 2022. The April data represents a 4.1% gain from March’s revised rate of 656,000,. The report was from the Census and Department of Housing and Urban Development and was reported Tuesday May 23. Economists had expected new home sales to decline to 670,000 from a March rate of 683,000. It was the largest month-over-month increase since December 2022.
Leading Indicators
PMI is forward-looking as it surveys purchasing managers’ expectations and intentions for the coming months. By capturing their sentiment on future orders, production plans, and hiring intentions, PMI offers insights into economic trends that have yet to be reflected in other after-the-fact indicators.
Home sales are considered a leading indicator because they can serve as a measure of other needs and broader economic trends. Home sales have a significant impact on related sectors, such as construction, home improvement, finance, and consumer spending. Changes in home sales can influence economic activity and indicate shifts in consumer confidence, employment levels, and overall economic health.
While many economic reports offer rear-view mirror data, these reports are true indicators of business behavior as it plans for future expectations, and consumer behavior as it is confident that it will have the resources available to purchase and outfit a new home.
The upbeat reports prompted the Atlanta Federal Reserve to raise its second-quarter gross domestic product estimate to a 2.9% annualized rate from a 2.6% pace. The economy grew at a 1.1% rate in the first quarter.
Take Away
Many economists are negative about the economic outlook later this year. Market participants have been positioning themselves with the notion that there may be a late year recession. Is the notion misguided? Recent data suggests there may be buying opportunities for those willing to go against the tide of pundits preaching recession.
No one has a crystal ball. In good markets and bad, there is no replacement for good research before you put on a position, and then for as long as the position remains in your portfolio.
Channelchek is a great resource for information to follow the companies not likely being reported in traditional outlets. Turn to this online free resource as you evaluate small and microcap stocks.
The Pace of the U.S. Treasury Burn Rate Toward a $0.00 Balance
The US Treasury Department is nearing its last ounce of blood as it has been bleeding operating funds. All parties know that the debt ceiling has to be raised if the country is to avoid a financial catastrophe. Still, an impasse on debt ceiling negotiations continues. While the House of Representatives has passed a borrowing cap plan, it is not expected that the Senate would agree on the spending reductions, and President Biden made clear he would not sign it.
The markets, of course, have been paying attention, but for the most part, they have chosen to ignore the drama. Anyone that has been involved in the markets for a few years knows that in the past, there have been stop-gap measures or 11th hour decisions that have avoided a US debt default.
It is Getting Close
The US Treasury reported last Thursday that it had $57.3 billion in cash on hand. As with any ongoing entity, each week, it receives revenue and pays expenses. So the daily balance runoff fluctuates by different amounts each day. A snapshot is reported each Thursday along with other US financial data. The current pace, while not a precise rate to gauge the net burn rate, is useful.
The operating balance used to pay our bills as a nation has declined from $238.5 billion at the start of May, when tax collections helped boost balances. That’s a $181.2 billion decline over 18 days, or $10 billion per day. If the pace holds, the United States balance sheet reaches zero before the June 1 date previously estimated by US Treasury Secretary Janet Yellen.
The US reached its Congressionally imposed borrowing cap in January. Since then, there has been a cutting back on spending, as had been announced in January by Janet Yellen. The Treasury has since been operating under an “Extraordinary Measures” plan, reducing less than critical spending to pay obligations that can not be ignored without great consequence. This bandaid approach will go on and, at this point, can only be “fixed” if the debt ceiling is raised once again by Congress.
Treasury Secretary Janet Yellen has been clear in warning lawmakers that the Treasury’s ability to avoid default could end as soon as June 1. The nation has to increase its ability to legally borrow to make its payments while its obligations exceed its revenue.
Averting a June Crisis Without Congress
While most US citizens are aware of the mid-April individual tax date, corporate tax dates are quarterly. The next time most corporations pay their estimated taxes is June 15th. If Secretary Yellen can squeeze the Treasury balances until June 15th, she will no longer be driving on fumes – instead, she will have added a little more gas, not enough to get her to the next corporate tax date.
Another thought depends on one’s interpretation of the 14th Amendment. This amendment of the US Constitution contains several provisions, one of which is Section 4. This section states that “the validity of the public debt of the United States, authorized by law… shall not be questioned.” While the exact interpretation of this provision is a matter of legal debate, it has been suggested that it could potentially provide a legal basis for the government to continue meeting its financial obligations, even if the debt ceiling is reached.
Some argue that the 14th Amendment could empower the President to bypass the debt ceiling and ensure that the government continues to pay its debts on time, based on the principle that the United States must honor its financial obligations.
Although the date of $zero balance is not far off if the President and Senate doesn’t agree to the House plan, or if the House is inflexible, negotiations have moved in fits and starts with Congressional leaders meeting on and off with each other and with the Executive branch.
If the nation does default, it will unleash global economic and financial upheaval. The full consequences are not known since it’s never happened before. Those likely to see funds come to a crawl or be turned off are:
Interest on the debt: While the debt itself would continue to be serviced, a stringent austerity plan could potentially result in reduced payments towards interest on the national debt.
Government programs and agencies: Funding for discretionary programs, such as infrastructure projects, education initiatives, environmental programs, or research grants, could be reduced or eliminated.
Social welfare programs: Payments for social welfare programs, such as unemployment benefits, food assistance, housing subsidies, or healthcare subsidies, may be reduced or scaled back.
Defense spending: Military expenditures and defense contracts may face cuts, impacting payments to defense contractors and the procurement of military equipment and services.
Government salaries and benefits: Austerity measures could involve salary freezes, reductions, or furloughs for government employees, including civil servants, military personnel, or elected officials.
Infrastructure projects: Funding for infrastructure development and maintenance, including transportation systems, highways, bridges, and public facilities, may face reductions or delays.
Grants to states and local governments: Payments to states and local governments for various programs, such as education, healthcare, or community development, could be reduced.
The above are not set in stone, it’s important to note that the specific impacts of an austerity plan would depend on the policies and priorities set by the government, and different austerity measures are also a matter of negotiation.
While Yellen, the Congressional Budget Office, and multiple other forecasters think the $Zero date is likely during the first two weeks of June, it’s possible that the Treasury will have enough funds to carry it through the middle of the month, which would add more time.
However, as it looks now, the US Government is running on fumes; in the past, it has not allowed itself to completely run out of gas. If today’s situation follows past history, the markets will get scared a few more times before the US leaders agree and the country is back to business as usual.
The FOMC minutes on Wednesday detailing the debate at the Federal Reserve’s May 2-3 meeting could be an eye-opener for investors. Expectations for many had been that the Fed would pause tightening. The Fed has publicly insisted that the interest rate moves are data dependent and there isn’t a scheduled plan extending through the rest of the year. If the minutes suggest pausing, markets shouldn’t react severely, if instead, the minutes suggest the Fed is panicking at the pace of the economy and persistence of inflation, the stock market may itself pause the recent bullish moves. Inflation data in the form of the PCE report Friday is not expected to show much improvement.
Friday is one of the bigger days for economic reports as Consumer Sentiment is released in the morning. On Friday afternoon, SIFMA recommends an early close before the Memorial Day weekend.
Monday 5/22
8:30 AM ET, James Bullard will be speaking. Bullard is the President and CEO of the Federal Reserve Bank of St. Louis. Bullard is an FOMC member and has been very vocal in his support for higher interest rates.
10:50 AM ET, Thoms Barkin will be speaking. Barkin is the President and CEO of the Federal Reserve Bank of Richmond. He is a member of the FOMC Committee.
11:05 AM ET, Mary Daly will be speaking. Daly is the President and CEO of the Federal Reserve Bank of San Francisco. She is a member of the Federal Open Market Committee (FOMC).
Tuesday 5/23
9:00 AM ET, Lorie Logan, CEO of the Federal Reserve Bank of Dallas will be speaking. She represents her district on the FOMC.
9:45 AM ET, The Purchasing Managers Report (PMI) has been signaling higher output for the last three releases. A number above 50 indicates an increase; the consensus for May is 52.6 versus April’s 55.9.
10:00 AM ET, New Home Sales, after a decent jump to a 683,000 annualized rate in March, new home sales in April are expected to have declined to 670,000.
1:00 PM ET, Money Supply numbers will be released. M2 is expected to have declined by 257.3 billion to a level of $20,818 billion.
Wednesday 5/24
10:30 AM ET, The Energy Information Administration (EIA) will be providing its scheduled weekly information on petr
oleum inventories, whether produced in the US or abroad. The level of inventories helps determine prices for petroleum products.
2:00 PM ET, The Minutes of the FOMC meeting held on May2-3 will be released. The minutes detail the issues, discussions, and positions among policymakers; the Federal Open Market Committee issues minutes of its latest meeting three weeks after the meeting.
Thursday 5/25
8:30 AM ET, Jobless claims for the week May 20, are expected to rise 6,000 to 248,000 following a 22,000 swing lower to 242,000 in the prior week.
8:30 AM ET, Corporate Profits are pulled from the national income and product accounts (NIPA) and are presented in different forms.
10:00 AM ET, Pending Home Sales data from April are expected to have risen 1.1%.
10:30 AM ET, Susan Collins is the President and CEO of the Federal Reserve Bank of Boston.
Friday 5/26
8:30 AM ET, Durable Goods Orders are expected to have fallen 1.1% in April following March’s 3.2% rise. Ex-transportation orders are seen down 0.1 percent.
8:30 AM ET, Personal Income and Outlays. Personal Income is expected to have increased 0.4% in April with consumption expenditures also expected to increase 0.4%. These would compare with March’s 0.3 percent for income and no change for consumption.
8:30 AM ET, Retail Inventories are expected to have risen by .73%.
8:30 AM ET, Wholesale Inventories are expected to have been flat in April risen by.
8:30 AM ET, International Trade numbers are expected to show the US goods deficit is expected to widen marginally to $85.6 billion in May after narrowing by $6.5 billion in April to $85.5 billion.
10:00 AM ET, Consumer Sentiment is expected to end May at 58.0, nearly 6 points below April but shigher by .30% from May’s mid-month 57.7 flash.International Trade numbers are expected to show the US goods deficit is expected to widen marginally to $85.6 billion in May after narrowing by $6.5 billion in April to $85.5 billion.
2:00 PM ET, SIFMA Recommends an Early Market Close on May 26 (2PM) and a Full Market Close on May 29 in the US in Observance of the Memorial Day Holiday.
What Else
Investment roadshows on company’s you own or have an interest in can lead to insights you’d never get anyplace else.
A stock that has the distinction of being Michael Burry’s longest held position (a long position) is a company named GEO Group (GEO).
On May 23rd and May 24th you may be able to attend a roadshow in South Florida presented by Senior Management of Geo Group.
Ben and Jerry Discuss Interest Rates, Jobs and Inflation
Federal Reserve Chair Jerome Powell reiterated today that the Fed is committed to bringing inflation down to its 2% target. Speaking at the “Perspectives on Monetary Policy” panel at the Thomas Laubach Research Conference, Powell said that the Fed will continue to raise interest rates until inflation is under control. The current Fed Chair shared the stage with former Fed Chair Ben Bernanke; the two more or less agreed, with Bernanke seeming a bit less optimistic.
The Panel Discussion
Powell acknowledged that the Fed’s actions to raise interest rates will likely slow economic growth. However, he said that the Fed is confident that it can bring inflation down without causing a recession.
“We understand that high inflation imposes significant hardship, especially on those least able to afford the higher costs of essentials like food, housing, and transportation,” Powell said and then emphasized, “we are strongly committed to returning inflation to our 2% objective.”
Powell reassured that the Fed is closely monitoring the labor market. The event is attended by experts in the field of monetary policy, including economists, central bankers, and other policymakers. It provides an opportunity for experts to share their views on the current state of the economy and the challenges facing central banks. Powell told the attendees that the Fed is committed to keeping the labor market strong but that it will not hesitate to take further action if needed to bring inflation down.
“The labor market is very strong, and we want to see that continue,” Powell said. “But we will take the necessary steps to bring inflation down,” he cautioned.
Ben Bernanke, the former Chair of the Federal Reserve, also spoke at the conference warning that the Fed is facing a difficult challenge in trying to bring inflation down without causing a recession. Bernanke said that the Fed will need to be very careful.
“The Fed is in a difficult spot,” Bernanke said. “It needs to bring inflation down, but it also doesn’t want to cause a recession. It will need to be very careful in its actions.”
Bernanke said that the Federal Reserve is facing a “new normal” in terms of inflation. He said that the Fed will need to be more aggressive in its use of monetary policy to bring down the pace of price increases. The former Fed chair said, “The Fed is going to have to be more aggressive in its use of monetary policy than it has been in the past,” He cautioned. “It’s going to need to raise interest rates more than once this year.”
Bernanke explained to listeners, “the Fed is not trying to cause a recession. But it is willing to risk a recession if it is necessary to bring inflation down.”
The comments from Powell and Bernanke took away any question whether the Fed is committed to bringing inflation down. Most listeners came away from this feeling the Fed is likely to continue to raise interest rates and to shrink its balance sheet in an effort to cool the economy and bring inflation down. However, attendees were also assured the Fed is keenly aware of the risks of a recession and is trying to avoid it.
What Does This Mean for the Economy?
The comments from Ben Bernanke and Jerome Powell suggest that the Fed is prepared to take aggressive action to bring inflation down. This could lead to higher interest rates and slower economic growth. However, the Fed is acting in a way it hopes leads to bringing down inflation without negative growth or a recession.
The bond markets had been pricing in an easing late in the year. US Treasury rates rose as the panel discussion got underway; this suggests that the tenor of some of the comments were unexpected. It is still too early to say what the impact of the Fed’s actions will be on the economy. However, it is clear that the Fed is taking inflation seriously and is willing to take steps to bring it down.
The next Federal Open Market Committee (FOMC) meeting will be held on June 13-14, 2023. The FOMC is the policymaking body of the Federal Reserve System. It meets every six weeks to discuss and set monetary policy, including the target for Fed Funds.
The next FOMC meeting is expected to be a critical one, as the committee will be making its decisions in the midst of sticky inflation, a troubled banking sector, and a slowing economy.
War Rooms and Bailouts: How Banks and the Fed are Preparing for a US Default – and the Chaos Expected to Follow
When you are the CEO responsible for a bank and all the related depositors and investors, you don’t take an “it’ll never happen” approach to the possibility of a U.S. debt default. The odds are it won’t happen, but if it does, being unprepared would be devastating. Banks of all sizes are getting their doomsday plans in place, and other industries are as well, but big banks, on many fronts would be most directly impacted. The following is an informative article on how banks are preparing. It’s authored by John W. Diamond the Director of the Center for Public Finance at the Baker Institute, Rice University, and republished with permission from The Conversation. – Paul Hoffman, Managing Editor, Channelchek
Convening war rooms, planning speedy bailouts and raising house-on-fire alarm bells: Those are a few of the ways the biggest banks and financial regulators are preparing for a potential default on U.S. debt.
“You hope it doesn’t happen, but hope is not a strategy – so you prepare for it,” Brian Moynihan, CEO of Bank of America, the nation’s second-biggest lender, said in a television interview.
The doomsday planning is a reaction to a lack of progress in talks between President Joe Biden and House Republicans over raising the US$31.4 trillion debt ceiling – another round of negotiations took place on May 16, 2023. Without an increase in the debt limit, the U.S. can’t borrow more money to cover its bills – all of which have already been agreed to by Congress – and in practical terms that means a default.
What happens if a default occurs is an open question, but economists – including me – generally expect financial chaos as access to credit dries up and borrowing costs rise quickly for companies and consumers. A severe and prolonged global economic recession would be all but guaranteed, and the reputation of the U.S. and the dollar as beacons of stability and safety would be further tarnished.
But how do you prepare for an event that many expect would trigger the worst global recession since the 1930s?
Preparing for Panic
Jamie Dimon, who runs JPMorgan Chase, the biggest U.S. bank, told Bloomberg he’s been convening a weekly war room to discuss a potential default and how the bank should respond. The meetings are likely to become more frequent as June 1 – the date on which the U.S. might run out of cash – nears.
Dimon described the wide range of economic and financial effects that the group must consider such as the impact on “contracts, collateral, clearing houses, clients” – basically every corner of the financial system – at home and abroad.
“I don’t think it’s going to happen — because it gets catastrophic, and the closer you get to it, you will have panic,” he said.
That’s when rational decision-making gives way to fear and irrationality. Markets overtaken by these emotions are chaotic and leave lasting economic scars.
Banks haven’t revealed many of the details of how they are responding, but we can glean some clues from how they’ve reacted to past crises, such as the financial crisis in 2008 or the debt ceiling showdowns of 2011 and 2013.
One important way banks can prepare is by reducing exposure to Treasury securities – some or all of which could be considered to be in default once the U.S. exhausts its ability to pay all of its bill. All U.S. debts are referred to as Treasury bills or bonds.
The value of Treasurys is likely to plunge in the case of a default, which could weaken bank balance sheets even more. The recent bank crisis, in fact, was prompted primarily by a drop in the market value of Treasurys due to the sharp rise in interest rates over the past year. And a default would only make that problem worse, with close to 190 banks at risk of failure as of March 2023.
Another strategy banks can use to hedge their exposure to a sell-off in Treasurys is to buy credit default swaps, financial instruments that allow an investor to offset credit risk. Data suggests this is already happening, as the cost to protect U.S. government debt from default is higher than that of Brazil, Greece and Mexico, all of which have defaulted multiple times and have much lower credit ratings.
But buying credit default swaps at ever-higher prices limits a third key preventive measure for banks: keeping their cash balances as high as possible so they’re able and ready to deal with whatever happens in a default.
Keeping the Financial Plumbing Working
Financial industry groups and financial regulators have also gamed out a potential default with an eye toward keeping the financial system running as best they can.
The Securities Industry and Financial Markets Association, for example, has been updating its playbook to dictate how players in the Treasurys market will communicate in case of a default.
And the Federal Reserve, which is broadly responsible for ensuring financial stability, has been pondering a U.S. default for over a decade. One such instance came in 2013, when Republicans demanded the elimination of the Affordable Care Act in exchange for raising the debt ceiling. Ultimately, Republicans capitulated and raised the limit one day before the U.S. was expected to run out of cash.
One of the biggest concerns Fed officials had at the time, according to a meeting transcript recently made public, is that the U.S. Treasury would no longer be able to access financial markets to “roll over” maturing debt. While hitting the current ceiling prevents the U.S. from issuing new debt that exceeds $31.4 trillion, the government still has to roll existing debt into new debt as it comes due. On May 15, 2023, for example, the government issued just under $100 billion in notes and bonds to replace maturing debt and raise cash.
The risk is that there would be too few buyers at one of the government’s daily debt auctions – at which investors from around the world bid to buy Treasury bills and bonds. If that happens, the government would have to use its cash on hand to pay back investors who hold maturing debt.
That would further reduce the amount of cash available for Social Security payments, federal employees wages and countless other items the government spent over $6 trillion on in 2022. This would be nothing short of apocalyptic if the Fed could not save the day.
To mitigate that risk, the Fed said it could immediately step in as a buyer of last resort for Treasurys, quickly lower its lending rates and provide whatever funding is needed in an attempt to prevent financial contagion and collapse. The Fed is likely having the same conversations and preparing similar actions today.
A Self-Imposed Catastrophe
Ultimately, I hope that Congress does what it has done in every previous debt ceiling scare: raise the limit.
These contentious debates over lifting it have become too commonplace, even as lawmakers on both sides of the aisle express concerns about the growing federal debt and the need to rein in government spending. Even when these debates result in some bipartisan effort to rein in spending, as they did in 2011, history shows they fail, as energy analyst Autumn Engebretson and I recently explained in a review of that episode.
That’s why one of the most important ways banks are preparing for such an outcome is by speaking out about the serious damage not raising the ceiling is likely to inflict on not only their companies but everyone else, too. This increases the pressure on political leaders to reach a deal.
Going back to my original question, how do you prepare for such a self-imposed catastrophe? The answer is, no one should have to.
The Market Will Experience a Barrage of Appearances by Fed Officials
This will be another week of various regional Fed Presidents speaking and setting expectations of potential adjustments to monetary policy; this includes Jerome Powell and Former Fed Chair Ben Bernanke. Retail and consumer health could come into sharper focus during the week as major retailers report earnings and April retail sales are reported early in the week. The initial results for the Russell Reconstitution of its main indexes will be released after the close of trading on Friday. Also, late week, Fed Chair Jay Powell will make an appearance on a panel with Ben Bernanke.
Monday 5/15
8:30 AM ET, The Empire State Manufacturing Index for May is expected to fall back to negative territory at minus 2.0 after April’s 35-point surge into positive ground at 10.8. This monthly survey of manufacturers in New York State is seldom market moving, but combined with other reports helps draw a picture of economic health within the region and more broadly.
8:45 AM ET, Ralph Bostic, the CEO of the Atlanta Federal Reserve, will be speaking.
9:15 AM ET, Neel Nashkari, the President of the Minneapolis Federal Reserve, will be speaking.
12:30 PM ET, Thomas Barkin, the President of the Richmond Federal Reserve, will be speaking.
Tuesday 5/16
8:15 AM ET, Loretta Mester, CEO of the Federal Reserve Bank of Cleveland, will be speaking.
8:30 AM ET, April Retail Sales are expected to rise 0.7 percent versus March’s 1.0 percent decline that, much of the earlier decline was led by declines in car sales and gasoline.
8:55 AM ET, Raphael Bostic will be speaking. Bostic is the CEO of the Atlanta Fed.
9:15 AM ET, Industrial Production is expected to be unchanged in April after March’s 0.4 percent increase that was boosted by utilities output. Manufacturing output is seen as up 0.1 percent after falling 0.5 percent in March.
10:00 AM ET, Business Inventories in March are expected to remain unchanged following a 0.2 percent build in February.
10:00 AM ET, the Housing Market Index has not been experiencing the steep declines witnessed last year. After April’s previously reported 1-point gain to 45, May’s consensus is no change at 45.
12:15 PM ET, John Williams, the President of the New York Federal Reserve, will be speaking.
3:15 PM ET, Lorrie Logan is the President of the Federal Reserve Dallas, she will be speaking.
7:00 PM ET, Raphael Bostic, will be speaking. Bostic is the CEO of the Atlanta Fed.
Wednesday 5/17
7:30 AM ET, Mortgage Applications, compiled by the Mortgage Bankers’ Association will be released. compiles various mortgage loan indexes. The index measures applications at mortgage lenders. This is a leading indicator for single-family home sales and housing construction.
8:30 AM ET, Housing Starts and Permits during March edged lower to a 1.420 million annualized rate; April is expected to slip further to 1.405 million. Permits, at 1.413 million in March and, though lower than expected, very near the starts rate, is expected to rise to 1.430 million.
10:30 AM ET, The Energy Information Administration (EIA) provides weekly information on petroleum inventories in the U.S., whether produced here or abroad. The level of inventories helps determine prices for petroleum products.
Thursday 5/18
8:30 AM ET, Jobless Claims Jobless claims for weekly period ended May 13 are expected to fall back to 255,000 after rising a steep 22,000 to 264,000 in the prior week.
10:00 AM ET, Philadelphia Fed Manufacturing Index, The Philadelphia Fed manufacturing index has been in contraction the last nine reports and very deeply so in April at minus 31.3. May’s contraction is seen at minus 20.0.
9:05 AM ET, Lorrie Logan, President of the Dallas Fed is scheduled to speak.
10:00 AM, Ecommerce Retail Sales, are sales of goods and services where an order is placed by the buyer or where price and terms of sale are negotiated over the Internet, an extranet, Electronic Data Interchange (EDI) network, or other online system.
10:00 AM, The Index of Leading Economic indicators, had plunged 1.2 percent in March, it is expected to fall a further 0.6 percent in April. This index has been in sharp decline and has long been signaling a pending recession.
10:30 AM, The Energy Information Administration (EIA) provides weekly information on natural gas stocks in underground storage for the U.S. and five regions of the country. The level of inventories helps determine prices for natural gas products.
Friday 5/19
8:30 PM ET, Import/Export Prices. Import Prices, an inflation harbinger is expected to rise 0.3 percent for April, this would end nine straight declines. Export prices are expected to rise 0.2 percent.
8:45 AM, John Williams, the President of the New York Federal Reserve, will be speaking.
10:00 PM ET, Consumer Sentiment looking at the first indication for May, which in April fell 1.5 points to 63.5, is expected to fall another half point to 63.0.
10:00 AM ET, Quarterly Services is expected is focuses on information and technology-related service industries. These include information; professional, scientific and technical services; administrative & support services; and waste management and remediation services. These sectors correspond to three NAICS sectors (51, 54, and 56). The Quarterly Services Survey produces estimates of total operating revenue and the percentage of revenue by class of customer.
11:00 AM, ET, Fed Chair Powell, is joined on a panel titled “Perspectives on Monetary Policy” by former Fed Chair Ben Bernanke.
4:00 PM ET, The FTSE Russell Index reports the first list of stocks leading to the Russell’s Reconstitution in 2023.
What Else
Investment roadshows are like getting a front-row seat to information direct from management’s mouth. The most useful investor information often comes from the unplanned responses to questions during the roadshow – either asked by you, or other interested investors.
Noble Capital Markets has an expanding and interesting calendar of roadshows during the week and month. Some are in cities that are paid less attention to than the major financial centers. This week CoCrystal (COCP) will be presenting at roadshows in Miami, and Boca Raton, FL. For more details, and a complete list of roadshows and cities, Click here.
US Debt Default Could Trigger Dollar’s Collapse – and Severely Erode America’s Political and Economic Might
Congressional leaders at loggerheads over a debt ceiling impasse sat down with President Joe Biden on May 9, 2023, as the clock ticks down to a potentially catastrophic default if nothing is done by the end of the month.
Republicans, who regained control of the House of Representatives in November 2022, are threatening not to allow an increase in the debt limit unless they get spending cuts and regulatory rollbacks in return, which they outlined in a bill passed in April 2023. In so doing, they risk pushing the U.S. government into default.
It feels a lot like a case of déjà vu all over again.
Brinkmanship over the debt ceiling has become a regular ritual – it happened under the Clinton administration in 1995, then again with Barack Obama as president in 2011, and more recently in 2021.
This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of, Michael Humphries, Deputy Chair of Business Administration, Touro University.
Image: An 11 year-old sampling of possibilities from the RPC (June 19, 2012)
As an economist, I know that defaulting on the national debt would have real-life consequences. Even the threat of pushing the U.S. into default has an economic impact. In August 2021, the mere prospect of a potential default led to an unprecedented downgrade of the the nation’s credit rating, hurting America’s financial prestige as well as countless individuals, including retirees.
And that was caused by the mere specter of default. An actual default would be far more damaging.
Dollar’s Collapse
Possibly the most serious consequence would be the collapse of the U.S. dollar and its replacement as global trade’s “unit of account.” That essentially means that it is widely used in global finance and trade.
Day to day, most Americans are likely unaware of the economic and political power that goes with being the world’s unit of account. Currently, more than half of world trade – from oil and gold to cars and smartphones – is in U.S. dollars, with the euro accounting for around 30% and all other currencies making up the balance.
As a result of this dominance, the U.S. is the only country on the planet that can pay its foreign debt in its own currency. This gives both the U.S. government and American companies tremendous leeway in international trade and finance.
No matter how much debt the U.S. government owes foreign investors, it can simply print the money needed to pay them back – although for economic reasons, it may not be wise to do so. Other countries must buy either the dollar or the euro to pay their foreign debt. And the only way for them to do so is to either to export more than they import or borrow more dollars or euros on the international market.
The U.S. is free from such constraints and can run up large trade deficits – that is, import more than it exports – for decades without the same consequences.
For American companies, the dominance of the dollar means they’re not as subject to the exchange rate risk as are their foreign competitors. Exchange rate risk refers to how changes in the relative value of currencies may affect a company’s profitability.
Since international trade is generally denominated in dollars, U.S. businesses can buy and sell in their own currency, something their foreign competitors cannot do as easily. As simple as this sounds, it gives American companies a tremendous competitive advantage.
If Republicans push the U.S. into default, the dollar would likely lose its position as the international unit of account, forcing the government and companies to pay their international bills in another currency.
Loss of Political Power Too
The dollar’s dominance means trade must go through an American bank at some point. This is one important way it gives the U.S. tremendous political power, especially to punish economic rivals and unfriendly governments.
For example, when former President Donald Trump imposed economic sanctions on Iran, he denied the country access to American banks and to the dollar. He also imposed secondary sanctions, which means that non-American companies trading with Iran were also sanctioned. Given a choice of access to the dollar or trading with Iran, most of the world economies chose access to the dollar and complied with the sanctions. As a result, Iran entered a deep recession, and its currency plummeted about 30%.
President Joe Biden did something similar against Russia in response to its invasion of Ukraine. Limiting Russia’s access to the dollar has helped push the country into a recession that’s bordering on a depression.
No other country today could unilaterally impose this level of economic pain on another country. And all an American president currently needs is a pen.
Rivals Rewarded
Another consequence of the dollar’s collapse would be enhancing the position of the U.S.‘s top rival for global influence: China.
While the euro would likely replace the dollar as the world’s primary unit of account, the Chinese yuan would move into second place.
If the yuan were to become a significant international unit of account, this would enhance China’s international position both economically and politically. As it is, China has been working with the other BRIC countries – Brazil, Russia and India – to accept the yuan as a unit of account. With the other three already resentful of U.S. economic and political dominance, a U.S. default would support that effort.
They may not be alone: Recently, Saudi Arabia suggested it was open to trading some of its oil in currencies other than the dollar – something that would change long-standing policy.
Severe Consequences
Beyond the impact on the dollar and the economic and political clout of the U.S., a default would be profoundly felt in many other ways and by countless people.
In the U.S., tens of millions of Americans and thousands of companies that depend on government support could suffer, and the economy would most likely sink into recession – or worse, given the U.S. is already expected to soon suffer a downturn. In addition, retirees could see the worth of their pensions dwindle.
The truth is, we really don’t know what will happen or how bad it will get. The scale of the damage caused by a U.S. default is hard to calculate in advance because it has never happened before.
But there’s one thing we can be certain of. If the threat of default is taken too far, the U.S. and Americans will suffer tremendously.
Even a Short-Lived Default Would Hurt Money Market Fund Investors
While the U.S. Treasury is now at the mercy of politicians negotiating, positioning, and stonewalling as they work to raise the debt ceiling to avoid an economic catastrophe, money kept on the sidelines may be at risk. Generally, when investors reduce their involvement in stocks and other “risk-on” trades, they will park assets in money market funds. These investment products are now paying the highest interest rates in 15 years, which has made the decision to “take money off the table” even easier for those involved in the markets.
But, are investors experiencing a false sense of security?
Background
Money Market Funds (MMF) are mutual funds that invest in top credit-tier (low-risk) debt securities with fewer than 397 days to maturity. The SEC requires at least 10% to be maturing daily and 30% to be liquid within seven days. The acceptable securities in a general MMF include Treasury bills, commercial paper, and even bank CDs. The sole purpose of a money market fund is to provide investors with a stable value investment option with a low level of risk.
Unlike other mutual funds, money market funds are initially set and trade at a $1 price per share (NAV). As interest accrues, rather than the value of each share rising, investors are granted more shares (or fractional shares) at $1. However, the funds are marketed-to-market each day. Typically market prices don’t impact short-term debt securities at a rate above the daily interest accrual. But “typically” doesn’t mean always. Occasionally, asset values have dropped faster than the daily interest accrual. When this happens, the fund is worth less than $1 per share. It’s called “breaking the buck.”
When a money market fund “breaks the buck,” it means that the net asset value (NAV) per share of the fund falls below $1. In addition to quick valuation changes, it can also happen when the fund’s expense ratio exceeds its income. You may have gotten a notice during the extremely low interest period that your money market fund provider was absorbing expenses. This was to prevent it from breaking the buck.
Nothing is Risk Free
Just under $600 billion has moved into money-market funds in the past ten weeks. This is more than flowed into MM accounts after Lehman Brothers went belly up which set off panic and flights to safety. Currently, $5.3 trillion is invested in these funds; this is approaching an all-time record.
The Federal Reserve has been lifting interest rates at a record pace, the level they have the most control over is the bank overnight lending rate, or Fed Funds. This impacts short-term rates the most. Along with more attractive rates, stock market investors have become nervous. This is another reason asset levels in MMFs are so high – a high-yielding money-market fund that is viewed as risk-free looks attractive compared to the fear of getting caught in a stock market sell-off.
As discussed before, there are risks in money-market funds. And right now, the risks may be peaking. This is because government spending has exceeded the ability for the U.S. to borrow and pay for it under the current debt ceiling limit. The limit was actually reached last January when it was addressed by kicking the problem further down the road. Well, the road now ends sometime in June. In fact, U.S. Treasury Secretary Janet Yellen said the U.S. government may run out of cash by June 1 if Congress doesn’t act, and that economic chaos would ensue if the government couldn’t pay its obligations. Not paying obligations would include not paying interest on maturing U.S. Treasuries.
It isn’t a stretch to say the foundation of all other securities pricing is in relationship with the “risk-free” rate of U.S. debt. That is to say, price discovery has as its benchmark that which can be earned in U.S. debt which has been presumed to be without risk of non-payment.
What Happens to Money Market Funds in a Default?
In a default, the U.S. Treasury wouldn’t pay the full principle it owes on liabilities such as maturing Treasury debt – short term term government debt with extremely short average maturities is a staple of market funds. That is why the price of one-month Treasury debt has dropped recently, sending its yield up to above 5% from a 2023 low of about 3.3%. It has driven expected returns of MMFs up as well, but there is a risk that these short maturities may not get fully paid on time. Many fund providers’ money market funds would then break the $1 share price.
Breaking the buck can have significant consequences for investors, particularly those who rely on money market funds for their cash reserves. Because money market funds are considered a low-risk investment, investors may not expect to lose money on their investment. If a money market fund breaks the buck, it would diminish investor confidence in the stability of these funds, leading to a potential run on the fund and broader implications for the financial system.
Likelihood of Breaking the Buck
Money market funds breaking the buck is a relatively rare occurrence. According to the Securities and Exchange Commission (SEC), there have been only a few instances where MMFs have broken the buck in the history of the industry. The most significant of these occurred in 2008 during the financial crisis when one of the oldest money market funds, Reserve Primary Fund, dropped below $1 due to losses on its holdings of Lehman Brothers debt securities. This event led to a run on many money market funds creating significant instability in the financial system.
Since the Reserve Primary Fund incident, regulatory changes have been implemented to strengthen the money market fund industry and reduce the risk of funds breaking the buck. These changes include requirements for funds to maintain a minimum level of liquidity, hold more diversified portfolios, and limit their exposure to certain types of securities.
Take Away
Nothing is risk-free. Banks such as Silicon Valley Bank found that out when their investment portfolio, largely low credit risk, normally stable securities, wasn’t valued at what they needed it to be worth to fund large withdrawals.
Stock market investors that were drawn in invest in to rising bond yields also found that when yields keep rising, the values of their portfolios can drop just as quickly as if they were invested in stocks during a sell-off. While no one truly expects the current tug-of-war over debt levels in Washington to lead to a U.S. default, one can’t be sure at a time when there have been many firsts that we thought could never happen in America.
Inflation in Argentina so far in 2023 is running at 126.4%. Meanwhile, its GDP has declined by 3.1%. This certainly meets the definition of hyperinflation. Can this situation occur in the U.S. economy? Hyperinflation is when prices of goods and services in the economy run up rapidly; at the same time, it causes the value of the nation’s currency to fall rapidly. It’s a devastating phenomenon that has serious consequences for businesses, investors, and households. Below we explore the causes of hyperinflation, its effects on the economy, and some ways to protect investable assets against it.
Causes of Hyperinflation
Hyperinflation can be caused by a variety of factors, but one ingredient that is most common is excessive money printing by the country’s central bank. When a central bank allows excessive cash in circulation, especially if it is during a period of low or negative growth, natural economic forces that occur when there is an abundance of currency chasing the same or fewer goods, serves to drive up prices and down currency values. This inflation can quickly spiral out of control, leading to hyperinflation. Other causes could include shortages of goods or services driving prices up as demand outstrips available supply.
Effects on the Economy
Excessive inflation is not good for anyone that holds the impacted currency. Businesses can command higher prices, but they will also be paying higher prices to run their business and receiving payment with notes with far less purchasing power. This is because hyperinflation increases costs for labor and raw materials, weighing down profit margins. Less obvious, but certainly adding to the hardship, is that businesses may have trouble securing financing and loans during hyperinflation; this can limit their ability to function or grow.
For households and individuals, hyperinflation also rapidly decreases purchasing power, as prices for goods and services jump up. This lowers living standards in the country as people are forced to pay more for the same goods and services. Additionally, hyperinflation can lead to a loss of confidence in the currency. Behavior including the belief that items should be purchased now because they will be more expensive tomorrow leads to hoarding and other actions that create shortages and drives up prices even further.
How Some Prepare for Hyperinflation
Hyperinflation is rare, yet, once the wheels start turning, such as they did in Venezuela in 2016, or Germany in 1923, it is important for businesses and individuals to take steps to prepare for the possibility. Here are ways that people have prepared for excessive inflation in their native currency.
Diversify Your Investments: While some believe it is always prudent to stay widely diversified, it may offer even more protection when the economy goes through the turmoil of excessive inflation. Preparing in this way means spreading your investments across a variety of asset classes, such as stocks, bonds, real estate, and commodities. This will help by avoiding any one particular asset class that gets hit hard. Keep in mind, stocks are often a good hedge against moderate inflation, and precious metals have historically been looked to for protection in times of extreme inflation. Earnings of companies that export are not expected to suffer as much as importers.
Hold Some Assets Denominated in Other Currencies: This can include established digital currencies, foreign stocks, bonds, that are not denominated in your own home currency. By holding assets denominated in other currencies, you can protect yourself from its devaluation versus others.
Invest in Hard Assets: Hard assets, such as gold and silver, land, and even tools can be a good way to protect yourself or your business from hyperinflation. These assets have intrinsic value and can retain their value even if the currency they are denominated in loses value. Remember that if inflation remains, it is likely to cost more in the coming months for the same piece of office equipment that helps your business run more efficiently.
Cryptocurrencies: Keeping within the guidelines of diversification, more established tokens such as bitcoin and ether are considered by some to help protect from hyperinflation. A word of caution, cryptocurrencies have little history against currency devaluation and inflation. The theory however is these digital currencies are decentralized and not subject to the same inflationary pressures as fiat currencies.
Take Away
In 2018 inflation in Venezuela exceeded 1,000,000%, proving, when the recipe for higher prices is in place, the unimaginable can happen.
While there is no consumer or investor that can proactively impact a rising price freight train, if hyperinflation is expected, there are steps one can take to reduce the negative impacts. These financial steps can be as simple as buying things today that you expect to need later, and more substantially diversifying your portfolio toward hard assets, companies that export to countries not experiencing inflation, and even bonds with either short maturities or an inflation factor as part of the return.
