The Days Ahead:

  • More housing data and updated PCE inflation.

This Week:

  • We look at government shutdowns and the impact on markets
  • They’re messy but markets tend to look through them
  • Uranium prices are soaring
  • There’s a huge gap between supply and demand
  • And nuclear is a growing industry
  • No surprises from the Fed
  • But the Fed should take the win

Government Shutdown and Markets

I was hoping that a few weeks away from markets would make the whole government shutdown threat go away. No such luck. The last few weeks seem to have brought the prospect of a shutdown a few steps closer.

The government’s fiscal year runs from October to the end of September, meaning that come October 1st, 2023, the House, Senate and White House must agree on the amount of discretionary spending for the year ahead. This covers all spending except mandatory expenses like Social Security, pensions, Medicare and debt interest. The mandatory part accounts for around $4,300 billion, or 73%, of the $6,130 billion in government spending for 2023. The discretionary portion is around $1,600 billion of which $769 billion is for defense.

Some members of Congress would like to see discretionary spending for 2024 held to 2022 levels and a resumption of border wall construction. Overall it would require an 8% cut in spending from levels agreed to in the Fiscal Responsibility Act (FRA) at the time of the debt ceiling resolution in June. One reason this round of cuts is so rancorous is that the FRA set the discretionary spending at $1,586 billion, of which $949 billion, or 53%, was defense. Everyone thought there was a deal and the Senate duly passed all the appropriation bills. It now appears there’s no deal and the House wants further cuts in discretionary spending.

No one wants to cut the defense portion so the amounts we’re talking about aren’t large, at around $740 billion, which was agreed in June, and $690 billion which is the amount proposed by some Republicans. Someone, somewhere has to cut up to $50 billion if the current proposals are to be agreed upon (they probably won’t). Current GDP is $27,000 billion so it’s around 0.02% of GDP that’s at stake.

If there’s no agreement, then government agencies must cease all non-essential functions. Things like air traffic control, law enforcement, pollution clean-up, mail, and tax collection all continue but employees are not paid until the spending bills are cleared. Some high-profile departments, like national parks, and museums are closed. In other areas, things slow down. Transportation Security Administration (TSA), for example, are essential workers but in 2019, some did not report for work because they weren’t being paid. In the same year, it took only 10 air traffic controllers to stay home to cause major delays in air travel. The hassle factor of a shutdown is very high, less so the economic factor.

The cost to the U.S. economy is probably small with the major issue being that up to 800,000 workers won’t get paid until there’s an agreement. They will all eventually receive back pay but the timing means that consumption will take a hit. How much? It depends on how long the shutdown lasts. But a rough guess is that it could cut growth by around 0.2% for every week it goes on.

The good news, sort of, is that a government shutdown is a lot less serious to markets than a debt ceiling problem. Shutdowns are temporary, and everyone receives back pay. A debt ceiling break means the government can’t pay creditors and must run a balanced budget. Some people might think that’s no bad thing but failing to pass a debt ceiling would mean the loss of around 5% of GDP, two million jobs and a default. Compared to the estimated loss of 0.2% of GDP for a government shutdown, you can see why markets are scared of one but fairly relaxed about the other.

We looked at how markets moved in the four last government shutdowns and the short answer is “not much.”

Graph depicting SPX Shutdowns
Source: FactSet, 9/18/2023

We looked at market levels two weeks before and two weeks after shutdown day. In most cases the moves from before and after shutdown were a) modest at around 1% and b) cancelled each other out. In the December 2019 to January 2019 shutdown, the market was up 12.2% two weeks before shutdown day, it then fell around 11%, fell, and then rose 8.4%.

It looked like this:

Graph depicting S&P 200 day moving average.
Source: FactSet, 9/21/2023

The net loss was around 4% in the two-week period but the market recovered quickly. We’d also note that the 2019 shutdown lasted 35 days and the other three lasted an average of 11 days. There have been 10 government shutdowns since the first one in 1980, six of which were less than three days. In all cases, market reactions were small, short and a lot less severe than a debt ceiling problem.

Of course, none of this may happen as no one wants a shutdown. But accidents may happen. The good news is that markets remain pretty sanguine about it all.

Uranium Up

One item that caught our eye while taking a few weeks off was the price of uranium. It’s something we’ve rarely looked at because, well, nuclear power is in decline, uranium is hazardous to mine, hard to clean up, complicated to process and trading is very thin. Some days it doesn’t trade at all. So, we were surprised to see it spike by around 30% to a 12-year high in the last few weeks.

First, here are the prices.

Graph depicting uranium prices
Source: FactSet, 9/19/2023

Only around 15% of the world’s annual production of 49,000 tonnes of uranium is bought on the spot market. The rest is negotiated through long-term contracts, given the element’s use in weapons. Prices fell in 2011 (see graph) when the Fukushima Daichi nuclear power plant in Japan was destroyed in an earthquake. In the aftermath, some 20 of the world’s 449 reactors were closed. Prices dropped quickly as it was assumed “peak” nuclear was behind us.

We took the average of some contract prices, some company websites and also looked at a Canadian ETF (don’t buy it!) that buys spot uranium and the trend is clear: prices are up about 30% in the last two months.

What’s going on?

  1. Nuclear is a growth business. The number of nuclear plants is growing. It’s up from the post-Fukushima level of 429 to 440 today ,with another 60 under construction. The amount of nuclear power generated is around 2,700 TWh (terawatt hour) up 12% in the last four years. Globally, around 10% of electricity comes from nuclear power. In some places, like Sweden and France, it’s 40% to 70% and others, like India and China it’s between 3% and 4%. But in both countries, nuclear will grow rapidly. China produces around 54,000 MWe of power, or 14% of the world’s 391,000 total, from 55 reactors today. It plans another 168,000 MWe, a growth of three times, from another 154 pants in the next decade or so. Global nuclear power is expected to grow to 445,000 MWe, up 14%, by 2030 and 686,000, up 78%,  by 2040.
  2. It’s clean. The CO2 equivalent emissions per gigawatt hour (about enough to power 750,000 homes for an hour) for nuclear is 3. For wind, it’s 4, solar is 5, natural gas is 490 and coal is 820. If counties are looking to reduce emissions, nuclear is a clear option.
  3. Extended lives. Several countries are allowing plants to operate for up to 60 years. In the U.S. it’s up to 80 years. California’s Diablo Canyon nuclear plant, the state’s largest single source of electricity, recently sought a 20-year life extension from its scheduled close in 2025. It will likely get it.
  4. Uranium supply comes from some troubled places. Current uranium production is at 49,000 tonnes and demand is expected to grow to 83,000 tonnes in 2030 and 130,000 tonnes by 2040. Each nuclear plant needs around 27 to 50 tonnes of uranium a year to operate. A coal power station needs around 2.5 million tonnes of coal to operate. But the largest mining countries are Kazakhstan (43% of total), Canada (15%) and Namibia (11%). Russia is at 5%. It also supplies 12% of the U.S.’ annual uranium needs and is, not surprisingly, exempt from sanctions. The U.S. buys 95% of its uranium from foreign sources.
  5. Lots of demand but not a lot of supply. Uranium mines aren’t particularly complicated. But they are messy. About one ton of ore is required to produce one pound of uranium so the global mining industry has to move 98 million tonnes of ore to obtain the annual supply of uranium. That’s around 1,225,000 rail cars, which would stretch 17,000 miles. The ore is crushed, added to water and then leached with sulfuric acid, which dissolves the uranium. The resulting goo is then separated to leave the uranium.
  6. The mines aren’t complicated but making uranium is. The goo leaves unenriched uranium, or yellowcakes, which is no good for anything until it’s enriched with more uranium isotopes by converting it into gas. That gas is then put into a centrifuge and separated into enriched and depleted uranium. The depleted uranium is made into a metal and is incredibly strong. You’ll find it on the receiving end of an armor-piercing artillery round or on the inside of a radiation therapy machine.
    • The enriched stuff is then formed into a powder and compressed into pellets that go into ceramic rods which are the fuel rods you hear about in nuclear plants.
    • The rods last about three years in a nuclear plant after which you have to go through the whole process again
    • I’ve probably missed out a lot and any mining engineer would probably laugh out loud (I haven’t seen Oppenheimer yet and they probably explain it well there) but the takeaway is that it’s expensive and complicated. It’s also well described here.
  7. There aren’t enough mines. So, with annual production of uranium at 49,000 tonnes and demand growing to 130,000 tonnes, where are the new mines going to be? There’s plenty of uranium in Wyoming and Montana. Wyoming has uranium reserves equivalent to six years of supply at $50 a pound and 16 years at $100. But it takes time to bring all the resources online. One example is Western Uranium, a company which started in 2006, but will only start to produce in 2026. Even then it will only produce 2 million pounds or around 0.01% of supply. In other places in the U.S. uranium production is, well, unpopular at best, and criminal at worst.
    • New supply can come from a) reopening closed mines, or b) expanding existing mines in some of the trouble spots like Kazakhstan, Russia, Niger (where there’s been a recent coup), and Ukraine (whose production is down 90% since the Russian invasion) or c) starting new mining projects where there are known reserves but no operations like Mongolia, Namibia and many parts of China.

It’s also not as if miners will make much out of the price increase. As we mentioned, most uranium prices are not set on the spot market. They’re negotiated through long-term contracts. A company like Cameco is typical. It operates one of the largest mines in the world and produces 28 million pounds of uranium a year but has presold 215 million pounds for the next decade.

The uptick in prices won’t ease up any time soon. Governments are keener on nuclear power than a few years ago and see it as part of the net-zero and green evolution. The supply chains from Russia are intact but highly undesirable given the sanctions on nearly every other mineral that comes out of that country. Finally, mining is contentious, expensive and has very long lead times.

Some think the price of uranium will climb to $200 a pound in the next two years, a three-fold increase. That could be on the high side, but we think the price is unlikely to ease and that could mean higher energy and electricity bills for longer.

The Fed Met and Surprised No One

The Fed has done its utmost to not surprise markets and this meeting was no exception. Most people did not expect the Fed to increase rates from the 5.25% to 5.50% level it set in July. It had raised rates by a total of 5.25% in 11 out of 12 meetings over 2022 and 2023 and a pause had long been in the cards. It was described as a “hawkish pause” because the Fed left itself with the option to increase rates as data required. The wording of the press release barely changed from July.

What was interesting was the Summary of Economic Projections (SEP) or dot plot. This is where we reluctantly reproduce the Fed’s chart crime.

Graph depicting the Federal Reserve's participants assessments of appropriate monetary policy.
Source: Federal Reserve

It shows what every member of the Fed Open Market Committee, whether voting or not, thinks rates will end up in the next three years. The median expectations for 2023 didn’t change although more than half the members think there could be one more hike. We’d put in the usual warning here that dot plots are neither policy nor plan. They’re just forecasts made by different people using different factors. We’ve learned to be somewhat wary of them.

More interesting was the change for 2024 where the expectation rose from 4.6% in July, which implied 100 bps of cuts, to 5.1% now, which implies only 50 bps of cuts. That’s the hawkish bit. In the last three months the Fed has basically said “Don’t look for too many cuts in 2024, ok?”

There was plenty to like in the other parts of the SEP. First, growth was forecasted up by 0.5% for 2023 and 0.4% for 2024. Second, unemployment was revised down for both years and, third, core inflation was revised down for 2023 and unchanged for 2024. As one of our astute colleagues, Jim Lebenthal, said.

“Take the Win.”

Quite right!

As another friend mentioned, Chair Powell must be a Led Zeppelin fan because for the Fed, the song remains the same. The long-term policy is the same, at 2.5%, they continue to keep the door open for more rises and the 2% inflation target remains. He also mentioned that policy is tight (finally) and that there’s progress on labor and inflation. All in all, he’s just making sure the market knows they will hike if they see any bad data down the road. We don’t think they will but it’s a sensible position to take.

The initial reaction was for the 10-year U.S. Treasury to sell off. That probably won’t last. At around 4.4%, the level will be attractive for dip buyers.

The Bottom Line

The Fed meeting was the dominant news of the week. The Treasury sell off on Wednesday reached over to equities the following day. It was all to do with the “higher rates for longer” part of the Fed story. The better economic news in the SEP was taken for granted.

Elsewhere in monetary policy, we saw the Bank of England and the Swiss National Bank left rates unchanged. In both cases, inflation came down much more than expected. The currencies took it on the nose, with both sterling and the Swiss Franc down around 1% (that counts as “on the nose in the FX world!). Our takeaway is that inflation is slowing more than expected, despite the recent oil price surge.

The three things we’ll be looking out for in coming weeks is the government shutdown, the UAW strike and the impact of renewed student loan repayments. The market is well aware of all three but they do have the possibility to surprise.

Beyond that, we’ll enter the earnings season and we remain positive about what we’ll see.

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Art: Jenny Aitken (b. 1976)

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