May 19 – Both stocks & commodities firmed overnight amid encouraging signs of progress in the debt ceiling talks. There is even chatter that the House of Representatives could vote on an agreement next week, easing concerns on Wall Street. The VIX slipped below 16 overnight for just the third time in the past 18 months, reflecting a spreading calm in the investment world. The dollar index is trading near 103.3 this morning. Yields on 10-year Treasuries are trading at a two-month high near 3.70%, while yields on 2-year Treasuries are trading near 4.32%. Crude oil prices are nearly 1% higher in early trade, while the grain and oilseed sector bounces from recent sharp losses on pre-weekend profit taking.
Negotiations continue between the White House and the House of Representatives on a debt ceiling package designed to avert default on our nation’s debt, which currently sits at $31.8 trillion and climbing. A deal needs to be reached before the Treasury Department runs out of creative accounting tricks to shift money around to make payments. It’s generally believed that they will run out of time on these accounting gimmicks at some point in very early June. Both sides agree that default is not an option, but both sides will also see that as greater leverage to get what they want in the negotiations. The Republicans have the narrowest of margins in the House and the Democrats have the narrowest of margins in the Senate, which leaves open the possibility that a few could hold hostage the many to get what they want in order to get the votes, but it’s generally believed that whatever agreement is reached will have bipartisan support. As such, the market expects us to weather this storm and quickly move past it in the days and weeks ahead.
But this will not solve the longer-term problem. The United States continues to spend more than it brings in, and it is nowhere close to turning that around. This agreement will certainly not turn it around, nor has Congress shown the interest in turning it around. That’s a reflection of the American public who vote these representatives into office. America’s “greatest generation” took us through World War II by sacrificing for the future good. But today’s culture wants what it wants today and will pay for it another day. That “another day” is almost here, and it will directly impact all of us over the next several years, with implications for the markets.
The interest payments on $31.8 trillion at today’s short-term rates would be $1.6 trillion, but in reality, it is “just” $570 billion because a lot of the debt is still held by existing debt certificates at lower rates. Those will all be rolled – notice I didn’t say retired – as they mature at today’s higher interest rates. As such, the annual interest payments on the national debt are projected to be between $900 billion and $1.7 trillion four years from today, depending on what you expect interest rates to do over the next several years. That compares to projections that we will spend $1.7 trillion on Social Security payments four years from today, and better than $900 billion on national defense. The national debt is expected to be somewhere near $40 trillion plus/minus a couple of trillion dollars. Congress will need to deal head on with this issue over the next couple of years – likely either side of the next presidential election. That will require either a) a significant hike in taxes that would dramatically slow the economy, b) a dramatic cut in spending that neither party has shown an ability to accomplish, or c) monetizing the debt which devalues the dollar and is even more inflationary than we have seen to this point. China is watching this play out, and it is positioning itself to take advantage of the opportunity to assume a leadership role in the world when it happens.
The G-7 Summit is occurring in Japan this week, with leaders of these major economies tightening sanctions on Russia, including putting pressure on Germany to stop a surge in exports to countries surrounding Russia. The G-7 Summit also committed itself to supporting Taiwan, which angered China. Momentum had been going China’s way earlier this year, as it was seen as more of a world leader. But the momentum currently seems to be swinging away from China, with many western nations increasingly concerned with China’s aggressive stance on global economic and military issues. But in the end, the Taiwan issue will likely be a pivotal issue. Ukraine became a significant global issue due to Russia’s strong conviction that it posed a risk to its security as Ukraine strengthened its ties to the West, and the West’s strong conviction that Russia posed a threat to Europe if it won in Ukraine. Similarly, the lines are being drawn on Taiwan. China sees this as an internal matter of national security, and any defense of Taiwan is an attack on China’s national security. The West sees Taiwan’s independence as a key component to the freedom of the surrounding region and for free trade through the critical South China Sea. Again, both sides have drawn a line in the sand. Russia challenged that line in the sand last year, and we’ve been at war for the past 15 months. The question now is, will either China or the West challenge the line in the sand in the Taiwan Straits, and what will the consequences of that be, both militarily and economically for world trade? One thing we do know is that it is already impacting trading decisions, with China increasingly seeking alternative sources of necessary commodities as it diversifies away from the United States. That’s been a part of the collapse in Ag commodities, although we are seeing a pre-weekend profit taking bounce today.
