Earnings Crunch Time
Countertrend UST Rally, CBO Forecasts, Earnings Recovery Crunch Time, Growth Scare vs Recession Risk, Extending Duration
Countertrend UST Rally
(BN) CBO RAISES US 2024 DEFICIT-TO-GDP RATIO TO 6.7% FROM 5.3%
(BN) CBO BOOSTS 2024 US BUDGET DEFICIT ESTIMATE TO $1.9T FROM $1.5T
The three economic reports of note this week — May Retail Sales, the July Current Employment Statistics (CES) survey week for initial jobless claims, and May Housing Starts — were weaker than expected, thereby adding additional economic evidence to the unhealthy broadening macro price signal of all non-AI related economically sensitive sectors we discussed in last week’s note, The Good Place. Also, notable this week was the Congressional Budget Office updating their 10-year budget projections for higher government spending and larger deficits. These two forces run in opposite directions in terms of the impact on Treasury prices in the short run, but in the same direction over the longer run. The short version of our ‘50s-’70s bond bear market analog for the ‘20s secular increase in rates, is the lengthy unwind of WWII rate caps and Federal Reserve large-scale asset purchases (QE) reducing price insensitive demand, combined with growing debt and deficits in both the eras, increasing supply. For the MMT crowd and Biden Administration officials who believe the gap can be closed with increased revenues, history is not on your side. Receipts are endogenous to growth and have been relatively stable under a myriad of income tax structures. Outlays are exogenous in that they are determined by Congress. Consequently, USTs made a series of higher highs and lows from the ‘50s through the ‘70s, only recessions halted the increase, but ultimately fiscal stabilization policies in the ‘70s increased deficits and the Congressional ‘pay for’ was hotter inflation.
Treasuries have been rallying since late April due cooler inflation, increasing evidence of weaker demand for labor and flat quarter-to-date retail sales. If the Tale of Two Surveys debate is resolved in favor of the payroll (CES) data being more than ‘a bit overstated’ (Chair Powell’s press conference characterization), perhaps when the first estimate of the annual benchmark revision is released in August, the Fed will likely start cutting rates in September. While the initial reaction will be to extend duration led by 2s rallying to 4% (bull steepening), shortly thereafter we would look for the 9th consecutive 50+bp increase in 10-year rates beginning in Q3 running into 4Q. In other words, during the early stages of a preponderance of evidence sufficient to start rate cuts, USTs will perform reasonably well as a diversifying asset against more growth sensitive equities, however, unless a recession develops, reduced demand and increased supply, combined with rich valuation, will stop the rally in longer maturity USTs in its tracks. If the lagged Quarterly Census of Employment and Wages analysis proves inconclusive and the CES data continues to increase (in large part due to the absorption of foreign-born workers and government demand), USTs are likely to increase more than the average 3Q to 4Q 80bp increase in 10s from 2016-2023.
In a couple of discussions following last week’s note, we debated the efficacy of our price signal from cyclical equity sectors and took a deeper look at the earnings outlook, and we review our findings this week. We then extend that analysis to the risk that slowing growth develops into something more insidious and make an asset allocation change to cushion the impact of the developing growth scare.
CNBC Appearance Discussing Unhealthy Broadening Out & CBO Projections
Note: We did not go down the rabbit hole into tax policy with Joe Kernen as much as it would have been enjoyable; spending is the primary driver of debt and deficits and we wanted to make the point that there is a cost that is paid by the public through higher inflation.
An Update to the Budget and Economic Outlook: 2024 to 2034 Executive Summary
“Deficits In CBO’s projections, the federal budget deficit in fiscal year 2024 is $1.9 trillion. Adjusted to exclude the effects of shifts in the timing of certain payments, the deficit amounts to $2.0 trillion in 2024 and grows to $2.8 trillion by 2034. With such adjustments, deficits equal 7.0 percent of gross domestic product (GDP) in 2024 and 6.5 percent of GDP in 2025. By 2027, as revenues increase faster than outlays, they drop to 5.5 percent of GDP. Thereafter, outlays generally increase faster than revenues. By 2034, the adjusted deficit equals 6.9 percent of GDP—significantly more than the 3.7 percent that deficits have averaged over the past 50 years.”
60039-Executive-Summary.pdf (cbo.gov)