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September 22, 2023
The Days Ahead:
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.”
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:
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.
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.
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?
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 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.
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.”
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 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)
Please read important disclosures here.
Christian is a Partner in the North Bay office. Prior to joining Cerity Partners, Christian was Chief Investment Officer for Brouwer & Janachowski. He oversaw...
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Insights from Christian Thwaites, offering a retrospective of the past week and a forecast of the coming days.
As expected, the Federal Reserve (Fed) once again held the benchmark rate steady at 5.25%–5.50% at its October-end meeting.
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