More on the Debt Ceiling

Another Tuesday and another big meeting about the debt ceiling… President Biden and House Speaker McCarthy are set to meet again today regarding raising the government’s borrowing limit. Both sides seem like those Zax on the Prairie of Prax, foot to foot, face to face, if you’ll pardon my Seussian reference. Life goes on, as they say, and the longer never-budging continues the more dangerous it becomes.

As we’re all painfully aware at this point, not raising the nation’s borrowing limit would likely lead to a host of disruptive issues for the domestic and global economy and would, of course, also make us look ridiculous on the world stage. The bulk of global trade relies on the dollar and the safety and security it implies. That’s not something to mess with.

We discussed this last week, and I don’t want to bludgeon you with negativity or be overly Pollyannish. With all the rhetoric out there, including from government officials, let’s remember that a technical default by the US Treasury is incredibly unlikely. The politicians on both sides are singing to their bases about what is essentially a political issue, and I have to believe that none of them actually wants to bring the financial system to its knees – the fallout would be extreme and many of these politicians are too pragmatic for that, regardless of what they may say to the press.

But don’t just hear it from me. It’s good to have another perspective, this time from the folks at JPMorgan Asset Management.

The gist here is that the best place to hide, or to ride out expected volatility, is in Treasury bonds. Gold and some other commodities can help but are subject to wide price swings and timing them well is extremely difficult. That bonds equal safety might sound strange since those bonds are issued by the government potentially causing all the volatility. But if history is any guide those bonds performed well during the big debt ceiling standoff in 2011 and the financial crisis of ’08 and ’09, for that matter. Performance in 2011 was ironic because the talking heads on TV were suggesting that investors the world over would dump their Treasurys and buy something else, anything other than debt issued by the US. But investors did the opposite. So will that history repeat itself this time around? I hope the current debt limit debate never gets that far but, if it does, time and again investors have shown a willingness to buy government bonds when things get tough in the markets. I’m not suggesting that you put all your money into Treasurys, by the way, just that what you may already hold should act as ballast during potentially rough seas ahead. 

Let me know if you’d like to review your portfolio as it pertains to all this or just talk it through.

Here’s the note I mentioned from JPMorgan...

From the Federal Reserve (Fed) to banking sector weakness, investors already have a long list of risks to consider, to which they can now add heightened concerns around the U.S. debt ceiling. The U.S. reached its debt limit of USD 31.4 trillion on January 19th and has since been relying on funds in the Treasury General Account (TGA) and so-called “extraordinary measures” to fund its obligations. Initial estimates from the Congressional Budget Office (CBO) projected these measures would last until between July and September, but the CBO and Treasury Secretary Janet Yellen now expect the U.S. could run out of funding by early June due to smaller-than-expected April tax receipts.

Still, it is not our base case that the U.S. will default. Lawmakers have raised or suspended the debt ceiling over one hundred times since WWII and under every president since 1959. It is possible that political parties agree to a short-term extension or suspension of the debt ceiling and continue to negotiate over future spending. While budget negotiations may happen given high levels of debt and deficits and rising interest costs, the stakes should not be default.

Some are pondering alternatives to a debt ceiling deal. One option is invoking the 14th Amendment, which states that the validity of U.S. debt shall not be questioned, but that is subject to legal interpretation and could get tied up in the courts. Another option is that debt payments could be prioritized, although it is unclear that operationally the systems and procedures in place are equipped for this. Finally, the Treasury could issue and deposit a trillion-dollar coin at the Fed in exchange for funds in the TGA. This proposal has been largely dismissed by central bankers. Therefore, the path of least resistance is suspending or raising the debt ceiling.

Although default is unprecedented, the best point of comparison for markets is the 2011 debt ceiling standoff and subsequent credit rating downgrade. As highlighted in the chart below, equities faced considerable volatility but, interestingly, Treasury yields fell [meaning bonds prices rose]. Some may have anticipated a rise in Treasury yields as U.S. credit quality was in question, but yields dropped 120 basis points (bps) from one month before the debt ceiling agreement to one month following the debt downgrade. Part of this could have been anticipation of a recession as a result of the turmoil; it could also be attributed to safe haven flows. It should be noted that the flight to safety was likely amplified by the coinciding sovereign debt crisis in Europe. Importantly, there are no cross defaults of Treasuries, so even if there were a default, only the Treasuries that mature when the government runs out of money would default. This is why many money market funds have avoided T-bills that mature around the X-date to manage risk.

Traditional safe havens like gold and the U.S. dollar also protected during the 2011 episode. Gold surged 10.8% in the month leading up to the agreement, topping out three weeks later, up another 15%. The dollar lurched 1.4% in the week leading up to the debt ceiling agreement but mostly reversed in the two weeks following the subsequent credit downgrade.

While some investors may choose to hedge debt ceiling risks through the U.S. dollar and gold, high quality core bonds may protect if volatility picks up. If volatility fails to materialize, core fixed income should still be well supported by slowing economic growth and inflation, which are likely to weigh on bond yields in the coming months. 

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Dining in the Dark

Good morning and I hope your day is going well so far. I’m at a conference as I write so this week’s post will be brief. This is the first in-person conference I’ve been to in a few years for obvious reasons and it’s good to be back at it again.

This time it’s the Financial Planning Association Retreat and I hope to bring you some notes from my time here in the weeks ahead.

One tidbit was the opening session last night, Dining in the Dark. Attendees were led to dinner in groups of ten standing in a tight line, with one hand on the shoulder in front of you, because we were blindfolded! I had no idea we’d be doing something like this. I thought the name implied dining by candlelight, or some other “dark” culinary experience, whatever that might be. Instead, it was three courses over what had to have been at least 45 minutes in utter darkness. Apparently about 20% of the room had to remove their blindfolds for various reasons, while your humble financial planner was able to stick it out. I think I cleaned my plates, but I know I didn’t spill anything into my lap, so that’s good.

All this was a prelude to the opening keynote talk about perseverance, optimism, gratitude, and kindness, presented by a blind person. I’ve been to a bunch of these talks over the years and the speaker’s bios are meant to impress, but this speaker was one of the most impressive people I’ve heard by far. Corporate executives ascending high peaks a world away takes planning and fortitude and is certainly an impressive feat. But losing your site as a young adult and then intentionally planning and executing a fruitful life in the decades since has the weekend warrior climbers beat, hands down. Frankly, most of us have no idea what true adversity is and we’re lucky for it. It’s good to be reminded of that from time to time, and to add some more blocks to our gratitude foundation. It’s also good to be reminded of all that is possible if/when we get out of our own way.

Otherwise, I wanted to share a few notes on recent events in the banking sector. As you’re likely aware, this past weekend saw another shotgun banking marriage, except this time it was brokered by the FDIC between JPMorgan and First Republic Bank. JPMorgan, the largest bank in the country (by deposits) was allowed to get bigger by acquiring the deposits and most of the assets of First Republic, the SF-based institution that catered primarily to well off and entrepreneurial clients. I say allowed because JPMorgan’s too-big-too-fail size had technically precluded it from buying another bank, but the bank received special permission to do this deal. Frankly, the mega bank seems to be making out like a bandit here, but that’s just my opinion.

So what does this mean for First Republic depositors? This is a fast-moving situation, but JPMorgan says that all First Republic branches are open for business, the website still works, and current terms of deposits and loans should remain that way for at least a while. JPMorgan executives were understandably nonspecific about many details when speaking to the press yesterday, but this seems like pretty decent news overall for First Republic customers. (I think common stockholders get nothing, by the way.) The alternative was a full takeover and liquidation by the FDIC, which creates a lot of headaches for regular people trying to access their cash.

I mention all this because of what a non-event this seemed to be for the markets and the banking sector as a whole. (That was yesterday - markets are down a bit as I write this morning.) There are other banks with problems like First Republic but, at least at this point, none of them seem poised to tank the financial system or otherwise cause a ton of market volatility as they work through it. This is a good sign for the rest of us in that the banking sector has been able to absorb these issues without creating contagion like during the Great Financial Crisis. Let’s all be grateful for that!

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The Everlasting Promo Rate

Some time ago I wrote about subscriptions and how easy it’s become to let them accumulate. Our subscriptions can be a chunk of our monthly expenses, so it makes good sense to track them down, decide what to keep, and jettison those that are unused or simply no longer necessary.

This is easier said than done, however. Part of the reason for this is that many companies offering subscription-based services seem to have a knack for obfuscation. Maybe they make you call and wait out a sales pitch before canceling. Or maybe the company tucks the cancelation link somewhere so cleverly that people tend to just give up and let it ride for another year (or five!).

The Federal Trade Commission has recently proposed a new rule that would require companies to make it as easy to cancel services as it was to sign up for them or face a fine of up to $50,000. Industry groups don’t seem to be fighting this, so maybe we humble consumers might eventually get some relief. I hope so!

I mention this because after months of higher-than-expected inflation and months yet to go before we get back to something resembling normal, consumers are paring their spending back so far this year. We’re seeing this in the official retail sales numbers from the government that came out last Friday and in some corporate earnings reports, but also in surveys asking about things like subscriptions.

According to the following article from the WSJ, consumers report that their “biggest financial mistake last year” was paying for unnecessary subscriptions and that these totaled at least 50% more than assumed. While the actual dollar values could be relatively small for some households and many might suggest not sweating the small stuff, for others, such as those living on a fixed income, canceling some subscriptions can make a meaningful difference to cash flow.

The bottom line with subscriptions is we should try to evaluate the ones we have, especially those on autorenewal, and decide about keeping them going. This sort of diligence can help uncover money that’s being wasted because we’re not even using the service we’ve been paying for. It can also help us reduce the cost of services we enjoy.

For me an example of the latter is my Sirius subscription. For years I’ve had one of their basic services in my truck and have typically paid about $7 per month. That’s a promotional rate but I’ve been keeping it going. I calendar the annual renewal because otherwise the going rate is about $23 per month. So each year I log into my account, chat with a rep and ask for the discount, all of which takes maybe 10-15 minutes. The whole process is pretty annoying, but I do it after being burned by a roughly $30 per month OnStar service that I let hit my credit card for almost a year before shutting it down and couldn’t get all the money back. Yes, I’m still a trifle bitter about that… and don’t even ask about my McAfee experience.

Apparently lots of people let their promo rate lapse and move up to full price and let that ride for months or even years. It’s part of the business model for many subscription-based companies. The higher standard rates also subsidize the promo rate for new subscribers and those, like me, who keep asking for it. I tell myself that I’ll outright cancel Sirius as soon as they refuse to continue the promo rate because their service is obviously more fairly priced at $7 than $23, but they haven’t yet so I’m a happy subscriber.

Take my Sirius example and stretch that out over your subscriptions. Do services you enjoy offer a lower rate but just haven’t told you? Have you asked for a discount? Again, this might seem like small potatoes, but I think it’s a good exercise to go through from time to time. It will help lower your recurring expenses and provide a sense of ownership over your finances as inflation seems to be eroding it away.

Here’s the WSJ article I mentioned. Let me know if you get blocked by their paywall and I can send you the story from my account.

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A Few Quick Updates

There’s truly never a dull moment, whether in life or in the financial markets. As we look ahead to summer there’s a short but weighty list of issues to follow: the debt ceiling, the banking “crisis”, the Fed, interest rates and recession risk. All this is playing out at the same time and demands our attention.

You’ve likely been wondering about these issues and many of you have been asking, so here are some thoughts pertaining to each.

The debt ceiling debate –

Treasury Secretary Janet Yellen recently said that Congress not raising our government’s borrowing limit would be a “catastrophe". I doubt she used that word lightly. As we’ve discussed previously, our debt ceiling is an arbitrary dollar amount that Congress has for years typically raised or suspended for a time. It’s been this way for over 100 years since the debt limit was created and, at least in modern times, has usually been subject to vigorous and often nerve-racking debate. This makes sense, of course, because all this deals with how much we borrow and that’s a sensitive topic for most people. (Even though the federal government isn’t a household and prudent borrowing standards we teach to our kids don’t necessarily apply, but I digress…)

So, while experts tend to agree that Congress failing to raise the debt limit, leading to missed payments and a technical default by the US Treasury, is not likely to actually happen, the same experts all expect political brinksmanship to take us down to the wire again. This is important as we’re nearing the so-called X Date when current “extraordinary measures to fund the government” dry up because the debt limit needs to be raised, not because we’re actually out of money. Our government can easily borrow more from domestic and global markets at any time.

President Biden and a variety of others are meeting on this later today. Both sides agree that the debt limit should be raised but fundamentally disagree on the means of raising it. That sounds about like a game of chicken where both sides agree they shouldn’t hit each other but neither is willing to veer away. Again, never a dull moment.

But how are the markets likely to respond? Here’s a good piece in this vein from PIMCO, the noted fund manager.

And here’s a recent press release from the Treasury department regarding this issue. There’s no shortage of cash and access to more, we just lack Congress’s permission to keep the wheels in motion.

The banking crisis –

I put the word crisis in quotes earlier because the problem’s depth is a matter of perspective. An interesting take on this comes from Gallup. The polling company recently measured how worried Americans are about the banking sector and the results were about the same as during the Great Financial Crisis, even though we’re not in the midst of that, thank heavens. And the poll was conducted last month before First Republic got swallowed up by JPMorgan!

We’re used to thinking of banks as solid and safe, even boring institutions, so it’s interesting to see how worried we tend to get about them. More educated and affluent Americans are less worried though, as are Democrats. This is flipped around from the GFC and presumably has something to do with who’s in the White House at the time. For example, in 2008, 55% of Democrats were “very or moderately worried” about banks, but as of last month Republicans held that same percentage spot.

Here’s the Gallup article.

Whatever the reasons and political affiliations, people are concerned about how safe their cash is. This is entirely reasonable given all the news and hyperbole about the financial system lately. We’re all now probably well aware of the basics of FDIC and NCUA insurance, so I won’t bore you with that again here, but please ask if you have questions.

Instead, it’s news this week that the banking system has been functioning much better after several weeks of uncertainty. According to my research partners at Bespoke Investment Group, banks are lending to each other again and deposits are on the rise, both for the top 25 banks by assets and smaller banks as well. This is good news after the huge drop in deposits at regional banks in mid- to late-March. Loans are also on the rise, especially at the smaller banks.

That said, I’d be surprised if there wasn’t news in the coming weeks of other smaller banks getting absorbed by their larger brethren. Just be prepared for that news and try to keep your balances within federal insurance limits just in case. It’s the prudent thing to do even though risk is low.

Interest rates and recession risk –

The Fed raised rates again last week by another 0.25%, bringing its benchmark rate to 5.25%. Markets are expecting that this will be the last rate bump for awhile and even that rates could start going down later this year. Why would they go down after going up so much in recent months? Recession.

This might take longer to materialize than some analysts were expecting even weeks ago. Unemployment is incredibly low, and wages are up while slowing consistently from a high point a year ago. Housing remains strong across much of the country and the consumer is still out there buying. Inflation is still high while coming down steadily. But employers are reporting fewer job openings and they seem to be prepping for a slowdown. There’s also an assumption that recent banking issues will put a dent in lending and demand, although that hasn’t shown up clearly in the numbers yet. That’s an example of the mix of economic data coming out lately, but the overall trend seems to be softening.

So that’s where we’re at right now and mixing it all together seems to indicate a banking sector that’s dodged a bullet, and a strong economy losing momentum that, in a perfect world, would only need to dip its toe into a recession. The 800-pound gorilla in the room is the debt ceiling debate and potential default, so let’s hope that cooler heads prevail in those fancy meeting rooms in DC.

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Happiness & Taxes

Tax Day has passed for most of us, so that’s good. Or at least partly passed in the case of those delaying their filing and payment until October due to the Federally declared disaster area in Sonoma County. For me getting past mid-April is a bit of a relief each year from no longer wondering what the final bill was going to be.

But it’s also a time for wondering just where all that money goes. Different organizations track this stuff and like so much else these days the answers are available online. What I found this time is from the National Priorities Project (NPP), an organization monitoring federal spending while advocating for peace, shared prosperity, and economic security for all. Who could argue with that?

NPP looks at the federal tax haul while also showing what taxpayers from individual states pay and where that money goes. They found that Californians, on average, paid almost $17,000 in federal taxes for 2022, about $3,500 over the national average. And how that money gets allocated across the federal budget is interesting.

For example, as the chart available by clicking the following link shows, almost $4,600 of that average tax bill went to “Health” spending, funding priorities like Medicaid (the largest single expense), Medicare, and the CDC. The next largest spending category was for “Military”, including a special carve out to Lockheed Martin and a subcategory for nuclear weapons costing about $94. The rest of the chart shows spending on a host of government services you’d imagine but, alas, only about $100 went to NASA and the National Science Foundation combined. That’s more than the nuclear weapons bill, but barely enough to buy a latte.

Of course we are who we are, and all this is what it is, so to speak. We have little direct control, if any, over how our government spends our money in any given year. But if you’re curious about where your tax money is going, check out this link for some quick reading.

Also, and perhaps only loosely related depending on your perspective, is a story from The Wall Street Journal about the happiest people in America. Tax time stresses people out and, when added to the plethora of bad news available at our fingertips 24/7, it pays to spend a few minutes thinking about our level of happiness.

According to a poll referenced in the story, the number of Americans feeling “very happy” has cratered in recent years. Those falling out of that category entered the realm of “not too happy”, while those claiming to be “pretty happy”, that middling level of happiness, has been flat over the same timeframe.

The very happy people were so few, only about 12% of the survey, that the WSJ reached out to learn more. They found some interesting common traits for what leads to happiness these days, and the story is available at the following link. One finding was that people said they got happier as they aged, which bodes well for those thinking about retirement. Physical activity and regular exercise were other common factors boosting happiness, and this regardless of age.

As before, let me know if you bump into the WSJ’s paywall and I can forward the story to you from my account.

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To Buy or to Wait

Recent weeks have seen a whipsawing of expectations for the economy and the path of interest rates. The yield on the 10yr Treasury, a key benchmark, rose to over 4% a few times and interest rates in general have been quite volatile. But the upward path seemed destined to continue as inflation headed higher and the Fed kept raising rates to fight it. Or at least that was the dominant narrative for a while.

Lately, however, expectations have shifted given that inflation has been steadily waning and the economy, for all its pluses, seems headed toward recession. That and recent news of bank failures has pushed more investors into bonds for safety and higher yields, which has pushed the 10yr Treasury yield back below 3.5%. Other investors now think they’ve missed the boat and that maybe they should wait for yields to go back up before buying more. But will rates go back up?

The following article from JPMorgan addresses this and talks about the queasiness some investors feel about bonds given such poor performance last year. That may be true, but we still need to navigate the market we have and not wait for the one we hope for. At least according to JPMorgan, the one we have is this: We’re heading into a recession, the Fed may cut interest rates to spur growth, yields track with what the Fed does, so the bond market offers a good opportunity right now.

That logic seems pretty straightforward but, of course, it’s never that simple. There’s lots of news out there about how this and that indicator always forecasts recession, and many do. But we’ve also never gone into recession when the job market remains this strong. The official unemployment rate is 3.5%, up a tick from a historic low in February.

Maybe we enter a recession, maybe we don’t. Either way, a lot remains to be seen and the outlook and dominant narratives are sure to shift multiple times in the coming months. If nothing else, yields on short-term investments are higher than they’ve been for a long time, so I think it’s wise to put excess cash to work now instead of waiting.

From JPMorgan…

At the start of the year, the term “soft landing” was a common refrain from both policymakers and investors. However, despite the most aggressive Federal Reserve (Fed) rate hiking cycle since the 1970s, growth has remained robust and inflation has moderated. The possibility that central bankers might have managed to thread the needle by bringing down inflation without damaging growth initially pushed recession forecasts out to 2024, but the banking crisis in both the U.S. and Europe has seen a sharp tightening in financial conditions as lenders strike a cautious tone and hold back on extending credit to the real economy. This was reflected in the most recent Senior Loan Officer Survey from the Federal Reserve, which showed a sharp tightening in lending standards to U.S. firms. If credit to the economy is choked off, then the ripple effects from recent bank failures could well pull forward the timing of any recession and potentially bring the Fed’s rate hiking cycle to a premature end. 

Following the latest Fed meeting on March 22, the Chair of the U.S. Fed, Jerome Powell, acknowledged that a credit crunch would have significant macroeconomic implications that could potentially influence the trajectory of Fed policy. However, he added that “rate cuts are not in our base case.” Despite the Fed Chair’s comments, market pricing of the pathway for the Fed Funds rate has shifted markedly in the last few weeks. Investors now anticipate that a Fed pause is imminent and that they will begin cutting rates as soon as September 2023 as growth slows and inflation continues to abate.

As the Fed ponders its next step, investors should be mindful that the window of opportunity that has emerged in fixed income may slam shut quickly. The yield on the Bloomberg U.S. Aggregate Index ended March at 4.4%, close to its highest levels in nearly 15-years. However, as shown in the chart below, the yield of the Bloomberg U.S. Aggregate Index is closely tied to the Fed Funds rate; in prior recessions, as growth has stalled, the Fed has lowered rates and bond yields have quickly followed suit.

After seeing the Bloomberg U.S. Aggregate Index fall by 13% in 2022 – its worst year on record – it is understandable that some investors may feel queasy at the prospect of jumping back into fixed income markets. However, it is important to remember that the yield of a bond benchmark provides a reasonable estimate of its forward return. As such, with the current yield offered by the bond markets potentially the high-water mark for this rate hiking cycle, investors could be well-served by taking advantage of this opportunity before the window begins to close. 

Here's a link to the article if you’d like to read it in situ.

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