By Benjamin Picton, Senior Macro Strategist at Rabobank
So, a debt deal is done, and now all that remains is for it to be articulated in a bill that can pass through Congress and be signed off by the President. This is by no means a fait accompli, but there should be sufficient support from both Republicans and Democrats to get it over the line before Janet Yellen’s revised X-date of next Monday. Early reports over the weekend suggest that a bill will come before Congress on Wednesday, with the hope of a speedy passage through both the House and Senate. Neither side is happy with the terms of the agreement, which probably suggests that it strikes the right balance.
The debt ceiling will be suspended for two years, which is just long enough to see Biden through to the other side of the 2024 presidential election. Republicans have extracted spending concessions from Biden that limit growth in non-essential spending to 0% in fiscal 2024 and just 1% in fiscal 2025. That represents a real-terms cut, but wasn’t enough for some of the fiscal hawks in the Republican Party who have pointed out that given that the national debt will hit $35 trillion in 2025 under this deal. Likewise, progressive Democrats are upset that Biden has agreed to any spending cuts at all. If the deficit had to be reduced, those members favored tax increases as the means to do it. Despite the Sturm und Drang it looks like the debt can has been kicked down the road once again and that financial repression remains the only real debt reduction strategy that has any prospect of actually working.
Of course, this would require some help from our friends at the Fed. The flow of data on Friday threw up some new challenges for the Fed’s thinking on the future path of the Fed Funds rate. The Core PCE deflator for April came in hot at 0.4% m-o-m vs expectations of 0.3%, and a prior read of just 0.1%. Likewise, personal spending in April lifted by twice as much as expected: up by 0.8%. That’s particularly striking given that personal income only rose by 0.4% in the month, and growth in spending was flat in the month prior. St Louis Fed data shows that average revolving credit balances have grown from the fourth quarter to the first quarter for the last two years, which represents one of the strongest gains we have seen since the mid-2000s. So, reading between the lines, it appears that Americans are spending more, but they are using credit to do it. That sounds an awful lot like Congress (until now, at least), and must weigh on the thinking of the Fed, whose primary tool for slowing the economy is to make that big stock of credit more expensive.
On that subject, the Cleveland Fed’s Loretta Mester suggested that a June rate hike was still a possibility, while noting that “progress on inflation is slow, concerning” and that it would be a mistake for the Fed to under-tighten and allow inflation to persist. She also said that she may revise up her inflation estimate at the June meeting and that she believes the Fed does need to tighten further, even if it doesn’t happen in June. A similarly hawkish Thomas Barkin of the Richmond Fed described labor demand in skilled trades as “crazy hot”, but Susan Collins of the Boston Fed was a little more sanguine. She said that the Fed is at, or near a pause in the hiking cycle, which is a view shared by Rabobank’s Fed expert Philip Marey. The strong run of data over the last few days has seen the traders up their bets on the future path of rates to the extent that a further hike is now fully priced in by July.
Elsewhere over the weekend we saw news that Turkish President Erdogan has been successful in his bid for re-election. Erdogan faced a strong challenge from Kemal Kilicdaroglu, but ultimately prevailed in the second round of voting. Erdogan’s victory has seen further pressure on the Turkish Lira, which is down more than 70% against the USD since the start of 2020, and concerns over Turkey’s dwindling foreign exchange reserves. Erdogan has been successful in positioning Turkey as an increasingly important player in geopolitics, especially since the Russian invasion of Ukraine, but opposition parties believed that unorthodox economic policies and very high inflation would be enough to convince voters to elect for a transition in power.
Turkey isn’t Robinson Crusoe in experiencing pressure on foreign currency reserves. We have seen similar troubles in Argentina, Sri Lanka, Lebanon and a host of other emerging markets in recent months. The rapid policy tightening and accompanying balance sheet runoff from the Fed is sucking dollar liquidity out of the market, and leaving some of those emerging economies unable to service their debts or pay for their imports. China and Russia have been helpfully stepping into the breach in an attempt to end the United States’ “exorbitant privilege” (and protect themselves from US sanctions), but as my compatriot Michael Every points out, the death of the Dollar-based system is much exaggerated.
So, another week of debt-ceiling chicanery beckons, but at least we are nearing the end of it (for now). While the big question around whether or not a deal would be done seems to have been answered, lots of new questions have now fallen out of it: Will the passage of the deal through Congress go smoothly, or will there be last minute spoil attempts? What does the reduced fiscal impulse mean for dollar liquidity and emerging markets? And does the debt deal give the Fed a clear runway for more tightening? I guess we will find out this week.
Preview of the Week ahead
Monday: The Memorial Day holiday in the United States and Bank Holiday in the UK should see a muted start to the week. Expect debt ceiling coverage to soak up most of the headlines. The one event for the day will be remarks by ECB Governing Council member de Cos.
Tuesday: New Zealand building permits for April kick us off. There is no survey estimate for this one, but don’t be surprised if the number looks rubbish. Both the RBNZ and the NZ Government have suggested that housing investment will be under pressure this year as rate hikes and high inflation keep developers on the sidelines.
- Shortly afterwards we will see employment data for Japan and April building approvals for Australia where survey expectations are for a gain of 2%. Spanish retail sales for April and the preliminary read of Spain’s May CPI will be next up. Surveyed economists are expecting CPI to print at 0.1% m-o-m.
- Later in the day we will hear from the ECB’s Holzmann, before the Conference Board consumer confidence numbers are released in the United States. The market is looking for a slight dip back below 100. To round out the day we get The Dallas Fed’s manufacturing index, and both Villeroy from the ECB and Barkin from the Fed will be speaking.
Wednesday: RBA Governor Philip Lowe is first up on a very busy day. He will be giving testimony before the Senate Economics Legislation Committee. This comes hot on the heels of leaked details of a private briefing where Governor Lowe reportedly told politicians to brace themselves for more rate hikes. Keep an eye out for comments on wages and productivity, as unit labor costs seem to be the chief concern for the RBA recently.
- Following Lowe, we have Japanese industrial production, as well as Aussie private sector credit and monthly CPI for April. The ANZ consumer confidence index for New Zealand will also be released.
- The highlight of the Asian session will be China PMIs for May. Here the manufacturing index is seen improving slightly to a still contractionary 49.5, while the services reading recedes slightly to 55.3.
- In the European session we will see preliminary May CPI data for France, where the y-o-y reading is expected to fall from 5.9% to 5.5%. This will be followed by French PPI and German employment data for May (unemployment expected to remain steady at 5.6%), before we see Italian CPI (7.5% y-o-y) German CPI (6.4% y-o-y) and the release of the ECB’s Financial Stability Review.
- In the US session we will get Canadian 1st quarter GDP data (2.5% annualized expected) before the release of May Chicago PMIs and the Jolts survey for April, where job openings are expected to have declined to just over 9,400,000.
The Fed’s Collins, Harker, Bowman and Jefferson will all be speaking, as will the BOE’s Mann and the ECB’s Villeroy and Visco.
Thursday: China’s Caixin manufacturing PMI is first up and expected to confirm a slightly contractionary read of 49.5. This will be followed by manufacturing PMIs for Spain, Italy, France, the UK, Germany, Canada and the United States, as well as UK house prices for May and German retail sales for April.
- US initial jobless claims will also be released with the market expecting a slight increase to 235,000 w-o-w. The May ISM survey closes out the day in data with the manufacturing index expected to slip 1 tick to 47, while the prices paid index is also expected to moderate slightly to 52.5.
- ECB speakers on the day will include President Christine Lagarde, Bank of France Governor Villeroy and Financial Stability Board Chair Klaas Knot. followed by the Fed’s Harker.
Friday: The morning brings Aussie home loan data and 1st quarter terms of trade numbers for New Zealand. Later on we get French industrial production and Spanish employment figures before the real hero of the day: US non-farm payrolls.
- Payrolls for May are expected to have increased by 190,000, while the labor force participation rate remains steady at 62.6% and the unemployment rate moves up one tick to 3.5%. Non-farm payrolls is always an important number, and doubly so this week as the market looks for further direction after the bullish end to last week.