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Treasuries have sold off on the strong, surprise jobs report last week.
At the same time, there’s been an equally important, but less well known surprise. The Treasury has maintained an increased pace of T-bill paydowns in the first third of August, despite the re-imposed debt ceiling.
That’s a short term bullish factor for bonds as it keeps pumping cash into the dealer and other institutional accounts that had been the holders of the T-bills being redeemed.
But it also means that the Treasury will spend its cash faster than I had initially imagined. That means that the bullish influence will end sooner than in my last guess.
I use the word “guess” deliberately. It’s difficult to estimate of what brilliant, but crazy, policymakers will make up when the heat is on.
The good news is that we now have evidence of a pattern. That pattern shows a fast spenddown. At this rate of spending, the Treasury will run out of cash in xxx xxxx (in subscriber report). As I recall from the past 7 debt ceiling debacles, there’s also a legal mandate that the government must make a large military pension fund contribution at the end of the fiscal year which will affect the drop dead date.
Maybe they can delay that for xxxx xxx xxxx (subscriber report) depending on the strength of mid September quarterly income tax collections. But at some point in xxxxxxx, the pressure to raise the debt ceiling will force a deal.
The jobs data was a surprise. As usual, the BLS first release is BS. The July nonfarm payrolls report grossly overstates the increase in jobs. The tax data is actual and, as I pointed out in the monthly Federal revenues report posted last week, withholding tax collections show that the payroll gains were certainly less robust than the BLS said they were.
As you may recall, back in the spring, there were a couple of months were the nonfarm payrolls gains were severely underreported relative to what the withholding tax collections were showing. I wrote then that the BLS data would catch up to the reality within a few months. I believe that the July report was the “catchup” month.
In our report on July federal withholding collections, we saw a dip in the second half of the month that suggested that the economy had fallen off a cliff. But withholding has now recovered to the trend in force since mid May (CHART in subscriber report). It is now at an inflection point where it should signal whether the economy has gotten back on track, or is in the process of rolling over. This should happen over the remainder of this month. I’ll post an updated chart when it happens.
The Wall Street talking head community, with a few Fedheads chiming in, is now in a growing chorus that the Fed will start tapering soon. Our analysis has been that the Fed can only taper if the Federal deficit is shrinking, thereby reducing Treasury supply. If the Fed were to taper in the face of constant or rising supply, the market would need to adjust in order to absorb the additional supply. Bond prices would fall and yields would rise.
This is where the revenue trend is important. If it weakens, the deficit will grow and supply will increase. This is even before considering the $1 trillion infrastructure spending package. If revenue growth stays strong, the Fed could conceivably do a small cut in QE (aka taper) without crushing the bond market. That could turn into the muddle through scenario.
The Treasury market rally of recent months has meant that Primary Dealers have built a profit cushion that would provide some protection in the event of bond market price weakness. In addition, initially, the supply increase that results from the lifting of the debt ceiling will be funded by the trillion + dollars that has been deposited in the Fed’s RRP program. That is still growing as the Treasury continues to pay down T-bills.
Those two factors will delay a bond market crisis for xxx xxxx (subscriber report).
It depends on when the debt ceiling is lifted, how much tax revenue the US economy is generating, and how much the Fed cuts its purchases of Treasuries and MBS as it begins the “taper.”
A muddle through scenario is always possible, but a crisis is also possible, if not more likely. The timing is in question, but it should come xxx xxxx xxxx xxxx (in subscriber report). The timing will become clearer as the trends of the data begin to show themselves once the debt ceiling is lifted. That includes the supply schedule, the trend of Federal revenue, and the Fed’s schedule of reduced purchases.
In the meantime, the status quo rules. As long as the Treasury is using its cash to pay down t-bills, the uptrend in stocks should continue. The selloff in Treasuries over the past week should reverse as those paydowns continue.
See the full report for the charts, more details on the supporting data and how we arrive at these conclusions, along with the timing, and an idea of the appropriate strategy under these conditions.
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Lee Adler