3% Treasuries, Say Hello To Trillion Dollar Deficits

Submitted by Nicholas Colas of DataTrek Research

In two months we will be in fiscal 2019 for the US government, and the OMB projects +$1 trillion/year deficits until 2021. Ten year Treasuries nosed over 3% today on news of some small but unexpected issuance, so where will rates go once deficits kick into high gear? And how will stocks discount higher rates, regardless of reason? Our answers below.

If the 10 Year Treasury were 4.0% at the end of 2019, would you expect US equities to be higher or lower then? It is easy enough to tell a story either way:

  • Bullish for stocks. Rising inflation caused by economic growth lifts both bond yields and corporate earnings. Companies push for greater efficiency to offset labor/materials costs, limiting margin erosion and (finally) increasing workforce productivity. PE multiples contract, but earnings growth more than offsets the decline and stocks rise.
  • Bearish for stocks. Rising inflation caused by escalating trade frictions lifts interest rates, but has a chilling effect on the economy and corporate earnings. The Federal Reserve likely avoids going full Volcker, and simply keeps rates constant in 2019 knowing an inflation-induced recession will take inflation lower without their having to become a political pariah. Multiples contract due to higher rates, but earnings are down 10% rather than the current forecast of +10%. The combination pushes US stocks lower.

Capital markets currently see the bull case as much more likely, and the other end of the yield curve – 2 Year Treasuries – supports that interpretation. It sits at 2.68% today, just 1 basis point off its post-Financial Crisis high, and has been moving upward all year. This is entirely consistent with the view that the Federal Reserve will respond to a strengthening US economy with higher rates through 2019. A trade war recession isn’t priced in at all.

The Fed Funds Futures market tells a similar story:

  • The odds of 2 more rate hikes in 2018 is up to 67% versus just 44% a month ago.
  • Futures also price in an all-but certain 50 basis point increase in 2019 (2 hikes), and a growing chance of 3 rate increases.

So far we’ve tread familiar ground, but we also want to point out one risk factor for Treasury yields that doesn’t get enough attention: rising levels of new issuance. This was one less-reported factor in today’s move over 3.0% in 10-Year bonds. The US Treasury surprised debt markets by announcing a new 2-month bill, an increase in the size of this quarter’s note auctions by $1 billion/month, and an August increase in bond auctions of a similar amount. More paper coming, in other words, and higher yields needed to clear them.

This announcement sent us to the Daily Treasury Statement (essentially the nation’s checkbook) to assess YTD tax/withholding receipts. These have been harder to predict in 2018, given tax reform and changes to withholding tables. The data:

  • 2018 Calendar YTD Tax/Withholding (Individual and Corporate): $1,752 billion
  • 2017 Calendar YTD: $1,769 billion
  • Difference: $17 billion, or 1% lower this year
  • This decline, while small, compares to a modest expected increase (0.2%) in 2018FY receipts as published by the Office of Management and Budget in their Mid-Session review last month.

The bottom line is that Treasury’s announcement likely stems from a revenue shortfall in 2018. Again, this is understandable. Tax reform happened at the very end of last year, and many companies were slow to change withholding tables or have their employees complete new tax forms.

This unexpected revenue miss is important, because it ties to how poorly the US balance sheet is set up for the next recession. Small shortfalls are OK, but the 2000-2003 recessionary experience (a pretty normal recession) saw a 12% decline in receipts over 3 years. Part of that was fiscal stimulus, and part was lower receipts. In total these swung the US deficit by $614 billion into the red.

The US faces a larger challenge now, because the OMB is looking for +$1 trillion deficits from 2019FY to 2021FY and there are no recessions baked into their numbers. Debt held by the public – the sort that markets actually have to absorb – rises by $3.4 trillion over that 3-year period. And remember that government fiscal years start in October, so we are 2 months away from a $1 trillion deficit run rate sitting here in August.

Pulling this discussion back to US equity prices, we have one question from all this: are markets ready for higher US Treasury rates if they are caused by incremental issuance and (perhaps) overly optimistic revenue estimates? Long-term rates are important mechanisms that allow the economy to self-correct in a recession. And whenever that comes, deficits will be larger than during any other non-recessionary period in history.

Comments

CheapBastard NidStyles Thu, 08/02/2018 - 20:01 Permalink

I personally look forward to 5-6% again. Deficits be damned!

Bush and Obama spent trillions on their wars killing people (and lining the pockets of the MIC pricks like Brennan and McStain) so it's time for the average ("dumbass fucking white") working American to get sumthink on their savings. I'm sure black people want more on their savings too, not only "dumbass" crackers.

We are going to see higher prices no matter what so why not get a few pennies more on savings.

PS: I'm glad the gook jeong didn't call us "deplorable, uneducated and irredeemable" Americans again, like that fat "dumbass fucking white" woman, Hillary Clinton used ta. That's so old hat.

In reply to by NidStyles

HRH of Aquitaine 2.0 dirty fingernails Thu, 08/02/2018 - 19:56 Permalink

They already have by allowing the IRS to prohibit debtors from leaving the US and blocking use of their US passport. Good luck trying to fly commercial or leave the country, legally.

Plenty of private pilots and boat captains out and about. Visit your local small airfield or yacht club and make friends. Most will take silver or gold or cash for fuel and their services.

In reply to by dirty fingernails

Oliver Klozoff DingleBarryObummer Thu, 08/02/2018 - 21:12 Permalink

You just figured that out now?

Tariffs HAVE to happen.

The wall HAS to be built.

nato HAS to pay up.

And all these things are happening.

Even with the tax cuts, the Treasury is raking in the dough.

Available jobs are popping, the place I work at is interviewing like crazy. Like never before.

If you can't see these are the good days, you are just a DUMB SHIT.

In reply to by DingleBarryObummer

Oliver Klozoff Oliver Klozoff Thu, 08/02/2018 - 21:57 Permalink

DV away! I luvs me some dv's!

While yer doin that, Trump is steadily plugging the leaks in our economy, is poised to close the cellar door to all the illegals, chasing out pukes like noname who "cost us a trillion dollars".

It's like when kilauea starting blarching last May, a volcanologist I know said "She's just clearing her throat, you ain't seen nuthin yet.

In reply to by Oliver Klozoff

MK ULTRA Alpha Oliver Klozoff Thu, 08/02/2018 - 21:14 Permalink

This is over with, we have negative growth because of inflation. It's not organic growth, it's from borrowed money and government spending for the mid term.

Productivity would have to increase significantly, it's not happening.

Most of the growth has been corporate stockpiling inventory in case of a trade war, Hurricane spending, the new massive military spending, and $500 billion in student loan growth since the recent about three years ago record student loan amount of a trillion, it's now $1.5 trillion.

Over 50% of Americans are still dirt poor working poor and these threads have now blamed the poor for being poor. It's too much to believe when everyone knows the economy has been roiled for the last thirty years, over and over roiled by design.

There are over 120 million checks coming out of Washington DC each month, there are posters who are getting a check and I know of one for sure who has condemned the poor for being poor. Well when the checks stop coming it's going to be funny.

Never before in our history has government borrowing been at this rate. I recently wrote it will clear a trillion deficit this year not next year, well with two months left in the fiscal year, it looks like well over a trillion dollar deficit.

We must purge over a million federal workers and their army of contractors now, return many agencies with redundant functions at the state level back to the states. At least one fourth of the federal government must be cut now to survive this.

One best get ready.

In reply to by Oliver Klozoff

opport.knocks Oliver Klozoff Thu, 08/02/2018 - 22:42 Permalink

You do not understand how the money lenders work. Before the parasite finally sucks the host dry they lay their eggs in the new host.

Just look at the timing of the Federal Reserve Bank 1913, right before WW1 and then WW2 finished the British Pound Sterling off as the world reserve currency. They were set up and ready to go in the USA when that happened.

The transition is happening already. How many times did Goldman CEO, Lloyd Blankfein travel to China between the 2009 financial crisis and now. When did the Yuan get added to the basket of IMF World Reserve Currencies.

Here, I will make it easy for you...
https://en.wikipedia.org/wiki/Reserve_currency

In reply to by Oliver Klozoff

Cosmicserpent MK ULTRA Alpha Fri, 08/03/2018 - 01:40 Permalink

We must purge the ARMY of CONTRACTORS. There, I fixed it for you.

Seriously though, the only way the deficit gets under control is to cut the military/spying/police state budget in HALF, for starters. That will save about $750Billion right there. Force these inefficient, lazy government leeches to go do something productive like dig holes and fill them up, aka, road building.

In reply to by MK ULTRA Alpha

Blackdawg7 dirty fingernails Thu, 08/02/2018 - 22:16 Permalink

Yup. Good prediction! There's actually a huge source of untapped potential in jailing hundreds of thousands of Americans who are delinquent on payments or have defaulted on their loans. And, if you think that either wing of The Corporate Party is going to do anything but legalize it, think again. Those A-holes in Washington know that the American people will suffer any beating, no matter how unjust. They've known it since they murdered Kennedy and nobody in America batted an eye at the 'lone shooter theory', and the response to 9/11 just confirmed what they already strongly suspected. Sadly, this country has become one giant feed lot, and it's the citizens who are on the menu.

In reply to by dirty fingernails

H H Henry P P … Bill of Rights Thu, 08/02/2018 - 20:32 Permalink

I am seriously considering that, at least when it comes to buying a home.  If I can get a nice $400k home with hardly any money down (since that money is going to gold instead), I would make the absolute minimum payments on a 30yr.  Dont care about filing bankruptcy when shtf because credit scores will mean nothing soon. Dont care what happens to the house 5yrs from now because gold holders will be able to sweep up the good stuff by then.

In reply to by Bill of Rights

justdues H H Henry P P … Thu, 08/02/2018 - 21:37 Permalink

Credit cards are unsecured credit (debt) . Think about that . If ,like me you are not easily intimidated , and never "contract" by acknowledging ones name and always answer a question by asking another question   e.g "Is this Mr Jones " ..."who wants to know ? "   ..."I need to talk to Mr Jones " ...me " Are your needs any of my concern ? " and so on , its quite fun winding them up and they never get anywhere .

In reply to by H H Henry P P …