The Debt Ceiling, Are You Ready For It? w/ Peter Boockvar

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1:24And now to the top analysis of today's markets.

1:34The debt ceiling. Are you ready for it? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Peter Buchvar, Chief Investment Officer at Bleakley Financial Group and editor of The Book Report. Hi, Peter. Hi, Maggie. Thanks for having me. Thanks for being on. We always love to see you. I kind of feel like we're all in wait and see mode. We have Republican House Speaker Kevin McCarthy scheduled to meet in 90 minutes with President Biden to see if they can get a deal on raising the U.S. debt ceiling and avoiding default. And the prevailing wisdom seems to be, at least in the market, seems to be that there will be a deal, even if it's ugly and drawn out at the 11th hour, they'll get one done.

2:15Is that the outcome? Is that what your sense that that's what the market's betting on? And is that wise? I mean, there will be a deal just like there is always a deal. But I think there are sort of two different things that are going on that just investors generally have to prepare for. One is sort of logistics in the sense of if I own a T-bill that is maturing called between June 1st on June 15th, so-called, you know, X-State range. And I need access to that cash on, call it June 5th, because I'm closing on a house June 6th. And if there's a day or two of disruption and I can't get my cash for that closing, then I have a problem.

3:06I don't expect, first of all, I expect a deal. You know, you're talking about two sides that are talking top, But at the end of the day, no one wants to preside over not making an interest payment on a particular day. So let's just say we go there. I don't expect that to last more than a day or two. So this is all going to be bluster, as it always is. And then we'll wait a year or two and have this happen all over again. Stretching this out, though, I think it's sort of unveiling a bigger challenge for the U.S. government and possibly markets in that it's exposing, obviously, how much debt we have.

3:51Not that we need this to expose it. You can go to a debt clock and see it. But looking at the U.S. budget deficit as a percentage GDP, right now we're at levels that usually coincides with the trough of a recession rather than a level that we're on the cusp of one at 7.3%. And also we have the dynamics of the Fed is selling treasuries essentially through QT. Banks are no longer loading up. Foreigner central banks have been net sellers. And at the same time, to finance that budget deficit, which is 7.3 % as a percent the GDP is at the end of April, we have a lot of supply. And once that debt ceiling gets raised, you're going to have a flood of supply in a very confined period of time as the Treasury refills their general account.

4:47I've seen estimates up to$500 billion within a month or two and worth of a trillion within the following six to 12 months. And just for perspective, the TGA is down to about$90 billion is each day and week that progresses from here. That'll get whittled down to zero. So what this all means in the short term is we're going to have the Treasury issue a lot of bonds over the coming couple of months. that will suck money out of the private sector because that's where the financing comes from. And maybe that means that it gets diverted from other places like the stock market, we'll have to see. Again, past this, it's going to matter for what does the U.S.

5:32dollar do? And can the U.S. government continue to finance themselves at current levels? Or do we need higher rates in order for them to do so? Yeah, which brings up a really, really interesting critical point, because we have the market anticipating that rates are going to go lower, right? I mean, that's what the forecast is. Well, I think the short end, the market definitely pricing in rate cuts after probably the Fed being done, even though they're certainly teasing us with maybe one more, or even if you're James Bullard, two more rate hikes. now we've reduced a bit of those odds and that we're only pricing in now maybe one hike by the end of this year, but a bunch next year.

6:19But the long end, you know, I have, I do my own work, but I listen to some other people and I'm quite amazed at the confidence that some people have on where the 10-year yield is going to go. And that is because they're only looking at U.S. growth and inflation and saying, inflation's slowing down, growth were going to recession, therefore you have to buy the 10-year yields are going down. And I just wish it was that easy of an analysis. I mean, look, today, the 10-year yield is closing at 372. And in my opinion, the economic growth story is only deteriorating. So I see slower growth. I see a tightening credit situation and yields have gone up.

7:07So what does that tell you about the state of things? I can argue that the 10-year goes to 3 % or even below if we're just looking at growth and inflation, but I can argue that the 10-year goes to 4.5 % and not for good reason. And I think we're getting a little bit of a taste of it over the past couple of weeks with this rise in the 10-year and that we're bigger picture, and maybe I'm speaking a little hyperbolic here, sorry, but we're unwinding the greatest financial bubble in the history of bubbles, and that's in sovereign bonds. So I just discount when some people have this very confident call where the 10-year yield goes.

7:44I can be confident of where the short end goes because that's tied to Fed policy. But if we can, in the next three months, wake up and the Japanese widened yield curve control, the ECB as they further tighten and do QT, they lose some control of their bond market. The Bank of England is outright selling gilts, and maybe they run into an issue again, and the exploding debts and deficits in the U.S., the 10-year can easily go above four and not for good reason. So that's very much the wild card is the long end. Short end, yes, we can argue that rates will go down into next year. And then the whole conversation related to that is, how much will they go down if we do go into recession?

8:29And how much will the Fed be able to respond to that? That is such an important point that you just made. I just want to sort of underscore, underscore, put a note and a pin in that because you don't hear a lot of people talking about that. And it's, except our really smart viewers, because right before you started, David Kelly asked, hello, Peter, will there be ample buyers of treasury once the debt limit is raised? So let me ask you, and I think you laid out a great argument of fact that that's not clear, unless the rates go up, the yield goes up to attract those buyers. Do you think it's because there's just so much supply coming on?

9:09Or is this a bigger picture of just less demand for U.S. Treasuries moving forward? Is it the glut or is it the overall attractiveness of U.S. Treasuries? Well, it's definitely a glut for sure. And then can that glut be absorbed? And it's going to be absorbed, but it's just a matter of what price. But losing the Fed as a buyer is a big deal. Losing foreign central banks as a buyer is a big deal. Losing the banks is a big deal. But on the other hand, insurance companies, pension funds are seeing yields they haven't seen in years. and we know money is flooding into money markets. Now, money markets, of course, are buying the short end.

9:55They're not buying the long end. But in terms of looking at the long end, are there enough buyers to offset? And it's very unclear at what the clearing price is for that supply to get absorbed. And that's why I push back on people that have so much confidence of where the 10-year yield goes. I think that it's just much more uncertain, as I stated. No, absolutely. So you mentioned before just the amount of debt that we're looking at heading into recession, not coming out. And I'm assuming a lot of that is related to the massive pandemic, you know, fiscal pandemic payouts and support. Or isn't everyone in the same boat?

10:44I mean, the U.S. is facing this, but isn't everyone kind of facing it because of what happened with the pandemic? Oh, for sure. But the U.S. government over two years spent$5 trillion, which at the time was, what, a quarter GDP. The Europeans did not. Now, the Europeans have created a sort of a slush fund, I would call it, between loans and grants. But as a percent of the euro zone or even EU GDP was a fraction, it was really the U.S. government that went hog wild with the spending relative to the size of our economy. I mean, we can just look back in 2020 and, you know, those collecting initial claims that half the people that were collecting them were making more on unemployment than they were previously on their jobs.

11:40So our GDP has gone somewhat exponential here relative to where I should say our debt relative to GDP has gone definitely exponential here, it seems. Hey, everyone, we're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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13:08So I think that we had Jared Dillian on. Some people are talking about in the chat, so I want to bring it up. We had him on, and I think he was touching on something similar, but just sort of saying, Listen, the 10-year yield could go to 10%. I mean, just threw that out there. But you said you don't know what the clearing price for that Treasury supply to be absorbed is. But is there a range you're looking at? Or are we really kind of in uncharted territory? I mean, right now, I'll take the easy way out, and I'll say 3.5 to 4.5. But I think what's most important here is if we break above 4 % in the 10-year, it's not for good reason.

13:50It's not because the U.S. economy is growing in size again to its normalized rate of 2 % to 3 % and everything is fine. It's going to be because of the things that we talked about, but also maybe because inflation remains really sticky. I was talking about inflation in April, May 2020 when the supermarket shelves were empty. So I would consider myself more hawkish when it comes to inflation. But I acknowledge that inflation is moderating, and it will continue to through the end of the year. But when you go like this, you usually come down like this. The question is, when you get to the other side, where does it settle out in?

14:36And I just don't believe, analysis that I've done, that inflation is going to settle out at 1 % to 2 % again. And that's going to be the sustainable rate of inflation for the next couple of years. I firmly believe it's going to be something more than like 3 % to 4%. Well, in a 3 % to 4 % new world inflationary environment, while it's below where it is now, and certainly well below the 9 %-ish level that we saw last summer, that's a new interest rate regime. That's a new inflationary regime that we haven't seen in a while. What 10-year yield should we put on that? I would say higher than we are today.

15:14So that's my worry, is that we get a rise in long rates and not for good reason. Yeah, I want to ask about the implications of that inflation in a moment. I want to zip up the debt ceiling part of this discussion. So that's something beyond the sort of short-term headlines that everyone's looking at. That's a really important thing to watch and part of the market. Wondering if you're also thinking about the dollar. My colleague, Andreas, tackled some of these short-term issues around the debt ceiling and his latest DenoSignals that dropped on the platform. Let's have a listen to a clip from that, and then we'll talk on the other side.

15:52I think the general narrative out there right now is that stress related to U.S. funding, stress related to treasury markets will lead to a sell-off in the U.S. dollar as a consequence of it. But if we look at the empirical evidence around partial shutdowns over the past few decades, we actually reach the exact opposite conclusion. So let's have a look at the dollar developments around the implementation of partial shutdowns in history. There is a tendency for the dollar to drop a bit ahead of the partial shutdown implementation. But as you can see from the chart here, in none of the four last shutdowns, the dollar has traded at a weaker level 100 days after the implementation of the partial shutdown.

16:40So it's essentially a 100 % hit ratio, at least if we look at the last four or five instances here, to be long the US dollar from the exact timing of the partial shutdown, which is in very sharp contrast to the overall narrative out there and which is in sharp contrast to the market positioning. Because currently we see a lot of active players in the market being short the US dollar in speculative positioning out there. So this could be a true game changer once we get to the point where the dollar trend reverses, if I'm right on my empirical analysis here of what happens in dollar markets, once we reach the point where a partial shutdown is very likely.

17:23um and and obviously andreas is is talking about what happens if they have to do a shutdown if the if things get messier than we're anticipating but i love the fact that he points out that the market is sort of very much expecting one thing um it's worth it's worth thinking about that full interview by the way is available on our platform if you're not a member you can scan the qr code so that you can join and get access to all of the great material including all the steno signals which drop weekly. So Peter, how are you thinking about this? Because as Andreas said, everyone's kind of betting one way on the dollar.

17:57If there's a deal, that risk goes away. But how are you seeing this in the short-term play out around the currency? When I look back on the dollar, and he can be right in the short-term about how it sort of responds to a disruption, but a disruption is going to be, like I said, just a matter of days. If you look back at the dollar, what's been driving the dollar since 2021, right before it sort of took off? And I'm going to really distinguish here and differentiate the dollar against different currencies because there's no such thing as king dollar. The dollar, right. Exactly. It's always the cross.

18:33Weston used to say that all the time. It's the dollar shrunk against some things and really trades like crap against others. So what drove the dollar rally, let's start by saying, looking at the dollar index, the euro-yen heavy DXY, where those two currencies make up about almost two-thirds of that index. It was June 2021 when at the FOMC meeting press conference, Jay Powell said, we're finally thinking about tapering QE. That was the match that lit the fire under the dollar. And the dollar took off right after that meeting and topped out at the end of October 2022, just as the Fed was ending its fourth meeting in a row of 75 basis point rate increases.

19:22So the U.S. dollar against the yen, the euro, the British pound was really just a Fed-driven rally. The Fed was more aggressive than other central banks. But once the market sniffed out, the Fed was about to slow down the pace of the rate increases. That ended the dollar rally. Well, what does that say about the dollar? Okay, so let's talk about now. Two of the largest trading partners of the U.S. economy is Mexico and Canada. Last week, the Mexican peso rose to its highest level against the U.S. dollar since 2016. The Canadian dollar, which is somewhat of a commodity currency and with oil prices down close to 70.

20:07Well, in the face of that decline in oil prices, the Canadian dollar has been trading in a range at 135. It's really no different than where it was over the last bunch of years. So there's really no dollar strength against the Canadian dollar. You look at the dollar against some of the Asian currencies. Well, I'm going to put aside the yuan because the yuan is trading really off the reopening excitement. And then now there's some reopening reality when it comes to China. But the Singapore dollar is near the higher end of its range. So I don't really see king dollar. Yeah, maybe there'll be a trade against the euro and the pound and maybe against the yen.

20:47But the yen is being driven by what the BOJ is doing right now, not what the Fed is doing. And now the Fed is just about done raising interest rates and tying back to that budget deficit as a percent of GDP. And if you go back 40 years, there is a relationship between the dollar and that deficit as a percent of GDP. Outside of a trade, I don't see the upside argument here for the dollar. Yeah. And I just want to be clear. Andreas, I think, is being very, because he does these weekly, very specific to the week and the risks that may result from the debt ceiling. You're talking about a little bit of a longer term thing, which is what the market, it seems like, is also anticipating.

21:31So if we are looking at, as you say, the potential where we may see the 10-year rate higher than expected because you've got to draw demand for treasuries, what are the implications for the real economy if we have a 10-year sitting at 4 %? Well, this is a potential problem, obviously, just from the natural belief that higher rates will be squeezed on borrowers. But taking this one step further, let's just say the U.S. economy does go into a recession, and the Fed is seeing the dip in inflation and thinking, OK, well, inflation's now got a three-handle. Maybe by year-end it's got a two-handle, that they can start cutting interest rates.

22:19well maybe what does that do to the US dollar if the Fed starts cutting I just argued that the sole reason for the dollar rally was the aggressive tightening of the Fed where do I think the dollar is going to go if the Fed starts to cut I would argue lower and if the Fed starts getting aggressive with their cuts and the dollar continues to weaken oil goes above 100 well the 10 year yield can go even well above 4 % in a slowing economy That would be a really difficult situation. So I'm not saying that that happens. I'm just saying that these are some realistic outcomes that tells me there's more chapters to this book on where rates go.

23:05Because like I said earlier, we're unwinding an epic bubble in sovereign bonds where negative rates were the definition of that. And just to think that, OK, we've ripped the Band-Aid off, yields are higher, and we're just going to go back to sort of pre-bubble trading and rates will stay low. I don't know. I'm not so confident in that. So like I said earlier, yields on the long end can go higher for wrong reasons and would sort of exaggerate the economic impact and make the Fed's job really difficult when they want to cut short-term interest rates in response to a weak economy. We're going to take another quick break to hear a word from our partners.

23:50We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

23:59does that put qe back on the table so if the economy is weakening and the markets the bond market is working against the fed they're going to have to do something other than cut rates right right well that that is the that is a great question because that then begs that situation begs that exact question is let's just say 10 the 10-year yield went up for those bad reasons and the Fed was forced to do what they can to cap that. Well, would that be successful? Maybe, maybe not. After QE1 and QE2 was implemented in an effort to suppress long-term interest rates, long-term interest rates went up instead because the market said, basically pushed back against the Fed and said, you guys are trying to reflate.

24:42I'm going to sell off my long-term treasuries. Right, right. This is why people talk about yield curve control, right? Yeah, I mean, that would be part of the conversation. But I think what we've learned from certainly the Japanese and most recently with the Reserve Bank of Australia, the yield curve control is an extraordinarily dangerous game. Because, yeah, it's easy to get in, but boy, is it really difficult to get out of. And the market's going to push you until you – they're always going to test your resolve. So you're going to have to throw a lot of ammunition at that line in the sand that you drew.

25:14Right. So, yeah, it's easy on paper to say, yeah, yield curve control. But in practice, it's going to be really difficult. And so these are some really difficult choices and situations that we're sort of gaming out here. And I think it's important to talk about it because these aren't low probability situations. I would say that these are potential outcomes. Yeah. So some of the questions I think we've answered as we went along, Cosmo's asking, why would the banks take on more U.S. bonds if they're underwater with them already? You're sort of saying the banks would be out of that. That's part of the problem, that you don't have them as a buyer this time around.

25:55Correct. They loaded up on this paper the last couple of years. And if anything, they're going to try to shrink this part of their balance sheet. They're hoping they can do that through maturities rather than being a forced seller. But yeah, the era of banks loading up. But banks don't necessarily have to because one of the reasons why banks loaded up on treasuries and agency bonds is because they got flooded with deposits. They got flooded with deposits because of all the QE the Fed was doing. Well, now deposits are shrinking and they're shrinking every single week. So there's less pressure on banks to deploy these deposits.

26:36Now, the loan-to-deposit ratio for the U.S. banking system is about 60%. The historical level is about 70%. So there is some room there, and that ratio will compress relative to its long-term average the more deposits leave. Now, the big banks don't mind deposits leaving because they have too many. It's the smaller banks that are obviously going to be challenged with the flight of deposits. Right. And John was asking, what does it mean for two to three year duration treasuries? I think you you made the case that they will follow Fed policy, but it's the it's the 10 year that's going to see the effect.