US debt ceiling: The crisis is overcome but the problem is not resolved

Markets are not some abstract creature with a mind of their own but are reactive to investors’ moods and so do nothing more than to track the flow of money. It may sound a little facile to repeat what should be the “bleedin’ obvious” but in an age obsessed with Artificial Intelligence, it’s not bad to remember that there are still significant investment decisions which end up being taken on whims. 

I was struck by a throw-away comment passed by the inimitable Morris Sachs in his most recent Inside Baseball with Old Chestnut podcast in which he noted that large swathes of smart money remain parked in the Treasury Bill market and that it will have some impact if, as and when it gets put back to work in risk assets and far be it from me to preclude longer dated government bonds from being included in that grouping. The longer end of the yield curve might in the past 12 months and in terms of yield not have waved about quite as much as the front end but in terms of price it has of course been a lot more volatile.  
 
So, if all this money which has been parked in the safe haven of the bills market were to be sent out into the big wide world, would it go into equities or into the fixed income space, be that of the government or the credit persuasion? A simple question, a staggeringly complex answer. There was much celebrating last week after the US debt ceiling standoff had been resolved, albeit that permitting a critically overborrowed federal government to borrow more is not exactly a resolution. The cold has been cured but the cancer remains largely untreated. 

Political fudges have a history of going wrong and none more so than the one known as the “Three-Fifths Compromise”. When the US constitution was being drafted and the allocation of seats in the House was being enshrined in accordance with the population of each state, the question arose as to whether slaves were to be counted as people or as possessions in the vein of cattle. The Three-Fifths Compromise, written into the Article 1, Section 2, Clause 3 of the new constitution, was how the crisis which threatened to scupper the whole process was bridged. Non-free persons who displayed, so the wording, a “mixed character of persons and of property ” were be counted not as whole persons but as three-fifths of a free person.
 
Later, when Missouri, where slavery was still present, was applying for US statehood but its joining the Union would have disrupted the balance between slaveholding and non-slaveholding states, a simple compromise was found by splitting Maine off from Massachusetts and creating a new state in which slavery was outlawed. The crisis was overcome but the problem not resolved. The outcome of the Biden-McCarthy debt ceiling crisis does nothing other than to kick the can even further down the road. And now back to the studio.

A significant backlog of Treasury funding needs has built up, as has by all accounts the pile of cash and near cash looking for something to do. The AI boom which is driving equity markets higher also looks to have developed enough momentum to attract some more cautious money which must be wondering whether it’s a bandwagon worth hopping on? On the other hand, if government needs to compete against the stock markets for the investment dollars on offer, it will need to be able to show something of a competitive return and not only risk-adjusted. 

For the better part of a decade I have argued that a 10 year note yielding less than 4% is not a place to be. The eye-watering losses now being carried by those investors who have portfolios stuffed with 0.5% US 10 year notes which they bought in early 2020 or even better German Bunds which as recently as October 2020 were yielding negative 0.5% cannot simply be brushed aside. Daily, weekly or monthly mark-to-market might gloss over and spread the capital losses but they do not alter the derisory coupon streams which have been locked in.

So should the cash be pushed into bond markets which will have to offer generous returns in order to attract the sort of capital required to finance Biden’s grand multi-trillion dollar spending plans or is the equity market just out of the starting blocks in pursuit of the next great epochal leap forward on the back of the AI revolution? The answer, I guess, is a bit of both and welcome to the lucky dip although at 5.23%, 3 month US bill still look pretty compelling as do UK bills at 4.46%. Eurozone rates across the curve continue to have relatively little to commend them to the discerning cross-currency investor.  

“Sell in May and go away…” seems to be a fair call even though there is currently a strong underlying bid in equities. I have already suggested that part of the tech rally must to some extent be relying on frustrated players seeking the next big thing in a market with only few dead certs on offer. As ever, the real money will be made by those who were first in and first out and their profits will have been provided by the latecomers. Is Nvidia also Nirvana? If you still like it at a P/E ratio of over 200, why not?

The nineteenth century Danish philosopher Søren Kierkegaard wrote that if he stuck his finger in the soil and sniffed it, he knew where he was. I did my little bit this weekend by attending an event dedicated to dogs called the Dogstival. It happens to be run by my niece and her husband and although in its fifth year, it is the first time I have been. Not wishing to appear too elitist, but it was a rare occasion where one can rub shoulders with a truly representative cross-section of society; all classes, all ages, bound together by their simple and unconditional love of their canines.  It was hugely good fun and the weather could not have been better although the feedback I received was that although footfall was only down a little, the decline in average spend was notable. The effects of the rise of the cost of living – I’m loath to repeat the catchphrase “cost-of-living crisis” for although it affects most of us, it is only in an unfortunate minority of cases truly critical –  are there for all to see. It didn’t feel like recession but there was clearly a tightening of purse strings. Government statistics follow the real world, not the other way around. 

I’ve done a lot of driving this week end and last evening fuelled my car at a litre price of £1.349 – that’s US$ 6.40/US gallon – the lowest price I’ve paid since before the Russian invasion of Ukraine and most probably since late 2021 when the price of carburant first began to rise. The argument since early 2022 for the huge rise in the cost of everything had been the price of energy which had affected the input from manufacturing to running farms to transportation. I cannot but conclude that with those costs back to late 2021 levels, someone is pushing the envelope. No disrespect to the likes of nurses, but their argument that they need a pay increase in double figures because it now costs so much more for them to get to work has just fallen off a cliff.

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