Debt Ceiling

The appalling fiscal and monetary situation in the U.S. will lead to further dollar weakness in the coming  months. This weakness will be most manifest versus gold as other fiat currencies have their own risks. 

Goldman, which is the hedge fund best known for originating prop order flow in the opposite direction of what its sellside "research" team tells its clients to do (see Tom Stolper), has never been clearer on gold: "Gold is slam dunk sell for next year because the U.S. economy will extend its recovery after lawmakers resolve stalemates over the nation’s budget and debt ceiling, Goldman Sachs Group Inc.’s Jeffrey Currie said." How the economy will expand, especially with the Fed supposedly tapering (even though everyone saw what happened to markets and the economy at the mere mention of "tapering" the last time around) and eventually ending QE - the only driver of upside market momentum in the past 5 years - was not discussed. What was, however, clear is that Goldman will continue buying all the gold its clients have to sell until the bailed out hedge fund's price target of $1,050/ounce is hit.

Markets are so obsessed by developments with the US debt ceiling, that absolutely nobody noticed that the Japanese Current Account (JPY152Bn, Exp. JPY520bn), Industrial Outuput in Spain (-2.0%, Exp. -1.6%), Factory Orders in Germany (-0.3%, Exp. +1.2%), Trade Balance in Germany (€13.1bn, Exp. €15.0 bn) and that the Jan-Aug tax revenue in Greece below expectations by 5.7%, all missed horribly, and that for all the talk of a European recovery (which was merely driven by a brief surge in Chinese credit spending making its way into the European pipeline) is once again fully and entirely premature. But with Congress on everyone's mind, even increasingly China and Japan, who cares about fundamentals: after all there is a Federal Reserve to mask the fact that nothing but liquidity injections matters. Even if that means a complete collapse in the actual economy as those separated from the Fed by one or more layers of banks, crash and burn.

We strongly suspect that both government debt growth and money supply inflation will continue unabated – any pause will immediately bring about the kind of short term economic pain these policies have explicitly sought to prevent and will therefore be quickly reversed. It is not unlike the situation the revolutionary assembly of France found itself in during the late 18th century: when it issued new money, industry seemed to revive. As soon as it stopped, industry slumped again. And so it was decided to issue ever more money, until the entire scheme blew up. There can be little doubt that modern-day governments are on the road to a similar date with destiny – and lately the speed at which they travel toward it has increased markedly.

Feel like you have missed any of today's (non) developments in the week-long government shutdown debacle, or the countdown to the debt ceiling X-Date, which now is 10 days away (or 222 hours as dramatically inclined CNN helpfully points out), then this summary is for you. From Bloomberg:

The chart below lay outs the amount of Bill, Note and Bond maturities between October 18 and November 15: it totals a whopping $441 billion... And according to our and the BPC's preliminary calculations, just focusing on simply paying down this debt in the all too likely case that the rollover machinery grinds to a halt, means that the Treasury would be about $180 billion short of paying down just the amounts due in the table above!

On September 26, when we wrote "As US Default Risk Spikes To 5-Month High, Here Is How To Trade The Debt Ceiling Showdown", we suggested a simple 1M/1Y Bill flattener, which has since resulted in a massive profit to those who put on the trade with appropriate leverage, leading to the steepest outright inversion the short-end curve has seen on record. For those who engaged in this trade, it may be time to book profits and move on, as the risk of a negative catalyst - a shutdown/debt ceiling resolution - gets higher with every passing day that we move closer to the October 17 X-Date. However, those who wish to remain engaged in the short end of the bond market where the highest convexity to the daily newsflow can be found, one possible alternative trade is to shift away from cash markets, and into shadow banking, via the repo pathway.

It would appear that President Obama's comprehension of the meaning of the word "negotiate" is different from that taught in the new "common core". Speaking at an event at FEMA, he noted:

*OBAMA: WILL NEGOTIATE AFTER GOVT OPENS, DEBT CEILING RAISED
*OBAMA: WON'T NEGOTIATE UNDER 'THREAT OF ECONOMIC CATASTROPHE'
*OBAMA TELLS CONGRESS TO 'MOVE BEYOND THIS MANUFACTURED CRISIS'

But given his comments last week on the markets' need to see this as a crisis, perhaps the best word to use to describe this farce is "inconceivable."

As we noted earlier there are some 'possible' scenarios that enable payments to be made on Treasuries prioritized over other payments but it would appear the short-term Treasury Bill market is becoming not just increasingly anxious about a technical default but is bringing that "X" date closer and closer. The 10/31/13 bill had been the "most risky" of the short-term bills until this weekend but the lack of a deal and no indication of a resolution any time soon has seen risk piling up in the 10/17/13 and 10/24/13 bills - the latter now at 16bps (that is 4 times the yield on the 11/21/13 bill). The 1-month-1-year spread is still inverted (even as USA CDS compresses on the day).

His government has ramped up spending to ward off unrest, helping drive inflation to a 15-year high last year, and pushing Algerians into the currency and real estate markets as they seek to shield savings.

“To protect themselves against inflation, and therefore the devaluation of the dinar, Algerians are investing in property, gold and foreign currencies,” Abderrahmane Mebtoul, a professor of economics at the University of Algiers, said in an interview. 

Overnight trading over the past week has been a bipolar affair based on algo sentiment about what is coming out of D.C. But which the last session was optimistic for some inexplicable reason that a deal on both the government shutdown and the debt ceiling out of DC was imminent, today any optimism is gone in the aftermath of the latest comments by Boehner on ABC, in which he implied that a US default is not unavoidable and that it would be used as more political capital, as it would be once again blamed on Obama for not resuming negotiations. As a result both global equities and US futures are down sharpy in overnight trading. And since the government shutdown, better known as a retroactively paid vacation, for everyone but the Pentagon (whose 400,000 workers have been recalled from furlough) continues it means zero government economic statistics in today's session with the only macro data being the Fed-sourced consumer credit report at 3 pm. This week also marks the unofficial start of the Q3 reporting season in the US with Alcoa doing the usual opening honous after the US closing bell tomorrow. JPMorgan’s and Wells Fargo’s results on Friday are the other main ones to watch to see just how much in reserves are released to pretend that banks are still making money.  As usual, expect disinformation leaks that send the market sharply higher throughout the day, which however will only make the final outcome that much more painful, because as during every US government crisis in the past, stocks have to plunge so they can soar again.

The federal government has been partially shut down for 4 days, and it appears likely that the situation could continue for a while longer. As the shutdown continues, the political focus has begun to shift to the next deadline.  If the debt limit is not raised before the Treasury depletes its cash balance, Goldman fears it could force the Treasury to rapidly eliminate the budget deficit to stay under the debt ceiling. They estimate that the fiscal pullback would amount to as much as 4.2% of GDP (annualized). The effect on quarterly growth rates (rather than levels) could be even greater.

While we documented (and predicted) the surge in October 31 T-Bill yields, now that the market is increasingly pricing in the probability of a (supposedly brief) technical default of short-term US debt around October 17, aka the "X-Date", a more disturbing development has been the rapid rise in November 14 Bills, as increasingly more traders become concerned not only about a failure to successfully negotiate away the debt ceiling, but the possibility of a protracted debt ceiling fight continuing well into November. So just what are the US government's key obligations in the immediate aftermath of the X-Date? Here, once again, is a breakdown of key events and cash "deliverables."

Argues that despite the growth the of the state in response to the crisis, what characterizes the current investment climate is the weakness of the state.  This asssessment is not limited to the US, where the federal government remains partially closed.