MARKET UPDATE October 6th, 2023 |
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First week of the fourth quarter of 2023 started off with volatility to the downside but major stock indices recovered on Friday. Bond indices are still down with yields running higher this week. The sharp moves in interest rates have been on everyone's minds lately, so thought I would offer a case for why some of these sudden upward moves in yields might go beyond the current narrative of “higher for longer”. I encourage you to read the three articles linked below for more. |
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“A national debt, if it is not excessive, will be to us a national blessing.” - Alexander Hamilton |
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THE FEDERAL DEBT I think that we all know that the government spends more than it takes in - otherwise known as the “deficit”. That difference, or deficit, is financed by the US in the form of new debt issued. That's all well and good in case of emergencies - like war, a global financial crisis or a pandemic - but in more normal times, anyone (government, individuals or companies) that spends more than it takes in can get into quite a bit of trouble. What Alexander Hamilton was saying in the quote above was that having good credit would surely come in handy for the newly minted United States. What he probably didn't mean was that the country's debt should balloon to an amount that exceeded the value of the economy as a whole. That would be bad for your credit. Below is the US debt versus gross domestic product (GDP). Beginning about ten years ago and accelerating with the pandemic, the value of US debt exceeds the total productivity of the economy and now ascends to something like 125% of GDP. |
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“R” MUST BE GREATER THAN “E” A high-priced consultant from a global consultancy (I'll give you three guesses as to which) came in to talk to the leadership team at my former firm. He told us in no uncertain terms that the key to business success was the “R” (he drew an “R” on the flip chart) must be greater than “E” (also drew an “E” on the flip chart). That was it! Eureka! That's all you needed to know about business. That Revenue must be greater than Expenses. Well, the US government might want to consider having this fella over for an enlightening chat. With the exception of four years (1998-2001), the U.S. has been running budget deficits since 1970 and that are now projected by the Congressional Budget Office (CBO) to exceed $2 trillion annually in 2030 (or earlier). |
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THE NUMBERS In this last fiscal year, the U.S. took in about $4.9 trillion in revenue, but spent some $6.7 trillion. To be fair, almost two thirds of federal spending falls into the broad category of “Mandatory”. What that really means is that it must be spent on what it was appropriated for - like social security, Medicare, etc. There's also a chunk that goes to paying the interest on the debt - which was created by the deficit spending. That eats up 8% now, but is projected to keep climbing by the CBO. |
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AN UNBLESSING Just a couple of months ago, a second credit agency (Fitch) downgraded the credit rating of the U.S. That's only the second time in history that this has occurred. Citing ballooning deficits and disfunction in governance, they issued warnings that future downgrades are possible. Think about it in terms of (what I call) the real world. If the U.S. had a near perfect FICO (credit) score before the first downgrade, it now has a second tier credit score. That means, if applying for a loan, they probably wouldn't get the best of the best rates. And if you keep racking up more debt, your credit score can keep going down and your future costs of borrowing will go up. Another thing - running deficits and issuing debt to cover the gap might be fine in broad economic terms - until fewer people are interested in buying your debt. If you keep going into hoc, eventually, the lenders can turn-off the spigot regardless of the rate you are willing to pay for the loan. I'm not suggesting that the US is there yet, but the market (through higher yields) is suggesting that you might want to get your fiscal house in order. |
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BOTTOM LINE - Earnings Season (Again)
- Producer Prices and more jobs data
WEEKEND READING (AND LISTENING) - Bond Selloff Threatens Hopes for Economy’s Soft Landing (WSJ)
- Rising Interest Rates Mean Deficits Finally Matter (WSJ)
- Higher Rates Stoke a Growing Chorus of Deficit Concerns (NYT)
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