Congress buys time and Kashkari's ode to the '90s
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As the U.S. government narrowly avoided a shutdown last week, rising oil prices assisted in pushing rates higher and strengthening the dollar.
After a week of headlines pointing towards a seemingly inevitable government shutdown, Congress passed a bill extending the budget until November 17 at the last hour. By passing this bill, Congress has bought more time to find middle ground on how to support Ukraine while looking to reduce spending. After the speaker of the House was forced to reach across the aisle to avoid a shutdown, more turmoil is likely to follow as some Republican party members felt betrayed by their leader. If a solution cannot be found before the new deadline, the good news is shutdowns caused by a failure to pass a budget are typically far less consequential than a failure to raise the debt ceiling. According to the Brookings Institution, a nonpartisan political think tank, “… [a government shutdown] applies only to the roughly 25% of federal spending subject to annual appropriation by Congress.” In other words, budgets for essential government functions and programs are authorized independently and will continue to function.
Since a government shutdown does not typically involve such an existential threat from a debt perspective, markets are historically and relatively unphased from the event. But, with the added context of the debt ceiling debate earlier this year there may be additional consequences concerning the U.S.’s credit rating. When Fitch downgraded the U.S.’s long-term credit rating to AA+ from AAA, they specifically cited last-minute resolutions and standoffs in fiscal policy making as a contributing factor to their deteriorating confidence in the government. Now as Congress enters another prolonged conflict over fiscal policy, Moody’s has threatened a negative outlook and even a downgrade if this debate does not result in a meaningful response to the government’s spending and debt situation.
Oil surging and consumer concerns
While this political showdown unfolded, the U.S. Treasury held another sizable auction with $134 billion of U.S. debt hitting markets last week. Despite this, rates trended higher across the board with the 10-year Treasury reaching its highest point since 2007 and closing at 4.57% on Friday. This was partly caused by surging oil prices as brent notched new highs for the year and closed in on $100 dollars a barrel. Markets fear that higher energy prices will cause inflation to stick around, though some relief was found on Friday as brent fell closer to $90 a barrel. The dollar followed suit reaching 10-month highs as markets are anticipating intervention by the Bank of Japan to bolster the falling yen.
Consumers voiced their concerns last week as the U.S. consumer confidence and Euro-zone economic sentiment September readings, and Germany’s forward looking consumer confidence reading for October all fell. So far there has not been any concrete evidence that would cause the Fed to consider rate cuts as the initial release for Q2 U.S. GDP came in at 2.1% and Core PCE at 3.9%. Hope in the E.U. that the end to rate hikes is near has risen, though, as last week’s inflation reading fell significantly to 4.3%.
Kashkari releases hawkish essay
These trends are consistent with the hawkish attitude on display by the Federal Open Market Committee (FOMC) members in the September meeting and subsequent public appearances. The Minneapolis Fed President and voting member, Neel Kashkari, mentioned he believes there is potential cause for rates to move “meaningfully higher” in an essay released on Tuesday. In his essay he notes the similarities of the current tightening cycle to the cycle in 1994, which is considered the only occurrence of a soft landing in the last 16 business cycles. In that cycle, rates remained considerably high for roughly five years accompanied by steady economic growth until the dot-com bubble.
As central banks diverge from a nearly universal hiking cycle, the market’s perception of the economy’s strength has changed with each headline. This led to a rapidly changing FX market over the last year and shifting volatilities. This could lead to completely different risk exposures from a year ago based on market conditions alone, making it increasingly important for companies to remain vigilant and actively assess where their risk lies. Even the yield curve has defied logic with long-term rates seeing higher volatility. Just last week, we saw a 25-basis-point difference between the high and low for the 10-year Treasury versus 23 basis points for the 3-month Treasury. These movements could cause headaches to any corporation with an unhedged debt issuance coming up.
In the week ahead, look out for key updates on the labor market with the JOLTs Job Opening coming out on Tuesday, ADP employment data on Wednesday, and the Bureau of Labor Statistics’ Unemployment Rate, Nonfarm Payrolls, and Average Hourly Earnings on Friday. ISM will also be releasing the Manufacturing PMI on Monday followed by the Non-Manufacturing PMI on Wednesday. And finally, next week marks the resumption of student loans for tens of millions of people in the U.S.
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