The Days Ahead:

  • The jobs report and national business surveys

This Week:

  • Treasury buybacks will start in the New Year
  • That should be good for Treasury prices way before then
  • Disability rolls are at record highs and have risen fast this year
  • We think it means there’s more slack in the labor market than it seems….
  • Which is good for inflation
  • Student loan repayments start again soon
  • We don’t think it will be a major headwind to the economy

Treasury Buy Backs

We wrote about Treasury buy backs last August and since then, this being the U.S. Treasury and the Treasury Borrowing Advisory Committee (TBAC), nothing happened.

As a reminder, what happens in a Treasury buy back is similar in concept to when a company buys back stock. Companies use cash to buy shares in the open market, cancel the shares and so reduce the share count. If earnings remain the same, and no company would really execute a buy back unless management were bullish about their prospects, they are spread over fewer shares. The earnings per share go up and the stock price should rise. Buybacks are almost always seen as a signal from corporate management that their shares are undervalued and is seen as a tax efficient way to distribute excess capital.

None of this applies to Treasury buy backs. The last time the U.S. Treasury made buy backs of significant size was in 2000, giving the following reasons (you can skip the next bit, it’s all about Treasury buying some types of bonds and replacing them with other types of bonds):

First, to Increase liquidity. The U.S. Treasury cannot always borrow across the maturity spectrum of 1-month to 30-years in equal or pre-determined amounts. Of the $24 trillion in U.S. marketable debt about 16% is in bills maturing in 3-months to 1-year, 57% is in notes, maturing from two to seven years and 16% is in bonds maturing in 20 and 30 years. The rest is in Floating Rate Notes (FRNs) and Treasury Inflation Protected (TIPS) at 10% and then a few other special issues.

The Treasury pays an average interest rate of 5.1% for the bills, 1.9% for the notes and 3% for the bonds. For the FRNs it pays 5.3% and for the TIPS it’s 0.56% plus inflation, currently around 3%.

Some of these bills, notes and bonds can become illiquid. Either they’re tied up on the Fed’s balance sheet, or they’re being pledged in the repo markets or they were not big issues in the first place. The Fed can use buy backs to improve the liquidity of any given issue by buying back securities where there’s a pricing or liquidity mismatch.

Second, is that the Treasury can change the maturity structure of all the debt. The way the yields are structured now, the Treasury is paying 1.6% more for a 4-month bill than a 30-year bill. The weighted average maturity of U.S. debt is 74 months but it was 50 months in 2009 and 61 months as recently as 2020. The Fed will probably want to shorten that maturity in the next few years.  If there’s more appetite for the longer bond, the Treasury can buy in the shorter notes and replace them with long bonds.

Source: TBAC

The horizontal line is the 43-year average at 61 months and the red line in the top right is 79 months, which is what the average will grow to if the Treasury keep issuing bills at current rates. In other words, to return that line to the long-term average, the U.S. Treasury must issue more bills.

Third, buybacks are a simple cash management tool. If there are too many bills outstanding and yields are too high, the Treasury can buy them in when cash receipts, as in tax season, exceed spending needs.

Finally, the Treasury can buy back certain new and more expensive issues and replace them with older lower yielding but similar debt. In the jargon, these are called on-the-run issues, which are liquid and very cheap, and off-the-run issue, which are not liquid and more expensive. One may have a 2-year maturity and the other 1 year and 10 months but it can be selling at a discount. The Treasury will then buy in the on-the-run bonds and reduce overall financing costs.

So, despite 12 months of silence, Treasury buy backs are now back on the table. In May, the U.S. Treasury said they would recommend a new buyback program starting in 2024. Officials announced it in the middle of the debt-ceiling negotiations so it didn’t receive a lot of attention. The reasons they gave to re-introduce the program after 20 years were vague, and no more clarity was given other than for “liquidity support and cash management objectives”.

We think the reasons are one, to reduce the overall maturity of the debt, two, to increase the bill market from 16% of all issuances to 25% and three to improve liquidity of the 10-year to 30-year bonds, many of which are sitting on the Fed’s balance sheet and thinly traded.  

It may not seem logical at today’s rates to issue more bills at 5.25% and fewer 10-year notes at 3.80% but it makes sense if you think that rates will fall.  If a year from now, bills are yielding 4% and two years from now 3.5%,  which is what the Fed projects, then the Fed achieves the first two objectives. It also solves for liquidity because the U.S. Treasury can buy holdings held by the Fed, which are essentially locked up and often illiquid.

The U.S. Treasury estimates the buybacks will run at around $5 billion per month and rise to $10 billion. Again, this differs from company stock buyback, when a program may be approved, completed in three months, 12 months, or not at all. The U.S. Treasury will be anxious to run the program on a “regular and predictable” basis. They will also announce and report on each purchase operation. The Treasury wants predictability and transparency. No one wants surprises in the world’s largest fixed income market.

Will any of it matter? It’s probably going to be a background issue but if, as we think, liquidity improves and the overall cost of financing the debt falls, then both investors and taxpayers should be happy.

Unemployment is Low but Disability is High.

Since January 2023, we’ve seen the number of people unemployed rise by 235,000 to 5,957,000 with the unemployment rate largely unchanged between 3.4% to 3.6%. The total labor force, which is the sum of those returning to the labor force after, say education or leave, plus those entering the labor force as they turn 18, has grown by 1.9 million to 166.9 million.

The number of new jobs created has been 1.7 million so if we add that to the increase in unemployed, we find that of the 1.9 million entering the workforce, some 1.7 million found jobs and 235,000 were unemployed. That’s a good ratio and, as we all know and the Fed continues to worry about, shows the labor market in pretty rude health.

But there are some other numbers which are more puzzling. Here from the Bureau of Labor Statistics (BLS):

Source: FactSet 7/25/2023

It shows the number of disabled people (blue) and as a proportion of the workforce (green).

Since January, the number of people on disability has risen 1.3 million to 34.1 million and as a proportion of the workforce to 13%. Both are the highest on record although the data only goes back to 2008.

In the last five years the disability rolls spiked by 4.8 million. Around 8 million of the 34 million are employed with a participation rate of 24% compared to 66% for the rest of the population. If the disabled had been counted as unemployed, the unemployment rate would be 4.3% not 3.6%.

Why the big spike in disability? First, it has nothing to do with disability insurance. The Social Security Disability Program pays benefits to 9.2 million people. The eligibility criteria to receive benefits are  strict, and include the need for a work history of at least five out of the last 10 years and have a disability expected to last over a year. The claimant must also face a five month waiting list, and will only receive benefits if they can do no other work. If you’re a carpenter with arthritis, you won’t qualify, because the Disability Determination Services (DDS) will likely conclude that you can do “other” work. Some 62% of claims are denied. So, the disability spike is not about generous benefits!

So, again, why the spike in disability?

It’s not that clear! Some ideas are that Covid-19 left around 1.2 million disabled. They would not qualify for benefits but they may be impaired enough that they can no longer work. Ageing is another reason.  Another is that the BLS disability questions are not that onerous. There’s no money or claims involved and the BLS asks about serious difficulties in walking or running errands. General morbidity has risen in recent years so it makes sense that more people might identify as disabled. Another reason may be that mental health is better diagnosed. Again, there’s no financial benefit or incentive attached to claiming disability when the BLS comes asking. It’s just a status and as far as the BLS is concerned only used as a demographic measure.

We don’t normally like to ask questions that we can’t find the answers to, but it’s clear that there are more disabled people but also that there are not more people filing disability claims.

We’ll take two tries at what we think it means.

One, the size of the workforce is over stated. The size of the U.S. workforce is 167 million of which 8.2 million are disabled and thus probably not available for work. That suggests the workforce is tight.

Two, the workforce has a lot of slack. There could be scope for a lot of workforce growth. Only 8.2 million of the 34 million disabled are working, with a participation rate of 24% compared to 40% in most advanced economies. The U.S. ranks 27 out of the 33 largest economies for disability employment rates.  If companies are short of labor, it seems disabled people would be a good start to source supply.

You’ll note that these are opposite conclusions! Our best guess is that there’s more slack in the labor market than the low unemployment rate suggests. Some of the labor growth will come from the growing number of disabled. That would be a good thing and good for inflation.

Paying Back those Student Loans

If there’s one thing you can count on it’s the steady increase in healthcare costs and college tuition. Both have far outstripped the broad level of inflation for years. Here’s the college tuition costs from the BLS’ consumer inflation report and healthcare inflation from the BLS’s Producer Price Inflation report.

Source: FactSet 7/26/2023

We use the producer prices because many health care premiums are employer paid. The price rises still impact consumers as anyone who’s visited a doctor will know from co-pays, deductibles and out of pocket medical cost.

But the price rises of both have risen around 30% more than general inflation over many years.

The college tuition line is in blue and, well, anyone who has sent a kid to or attended college in the last 20 years, knows the story. There was a brief respite in 2020 when fees fell slightly but that was when colleges were closed and everyone was zooming classes. As soon as full attendance came back, so did tuition inflation.

Incomes did not increase nearly as much as college tuition so college loans became a very big thing.

Source: FactSet 7/26/2023

The chart shows the outstanding level of student loans from the Student Loan Marketing Association or Sallie Mae. They’re now $1,493 billion or around 6% of GDP and 31% of all outstanding consumer debt. There’s also another $300 billion in student debt financed through colleges and bank loans, but we’ll focus on the Sallie Mae loans.

The total amount dropped by around $39 billion in May and will again in June because of fixes to income-driven repayment plans. Basically, people who should have had loans forgiven, because they became teachers or worked for non-profits, didn’t. So, the reduction was correcting up on a very large clerical error over many years.

But the rest of the $1,493 billion is still out there and, with June’s Supreme Court decision, there will be no more forbearance or loan forgiveness.

Back in March 2020, loan repayments and interest accrual were stopped as part of the CARES Act. The relief measure was extended 12 times from March 2020 to November 2022 but was stopped in June 2023. As of September 1, 2023, student loan interest will start to accrue and as of October 1, repayments will start again.

So, we wondered if the resumption of student loans would hurt the economy? After all, it leaves consumers with less discretionary income. The short answer is that it should have little impact.

There are 43 million people with student loans. The average student loan is about $36,000 and the typical borrower is college-educated with an above average income, but lower net worth, does not have children and their loan is about 61% of annual income.

If we assume the average interest rates range from 5% to 7.5% (add another 10% if it’s a private loan from companies like these), then interest and principal repayments will be about $90 billion a year or 0.4% of GDP or around 1.1% of monthly retail sales.

That sounds like it could hurt consumer momentum but we’d point out that the Sallie Mae loans are mostly at fixed rates and in nominal dollars. Every increase in incomes reduces the debt burden and any hit to spending. The loans also skew to the higher income brackets who also have higher savings. It’s unlikely that there will be a one-for-one reduction in spending for every dollar that will now flow to debt repayment.

There are other more dire forecasts of economic headwinds when payments resume. But, if that’s the case, we’d expect a quicker move to lower inflation. But we think the effect will be minor. We’ll know more in October.

The Bottom Line

The big news of the week was also the most predictable. The Fed raised rates by 0.25%. The upper limit of the Fed Funds rate now stands at 5.5%. The last time it was at that level was in February 2001, hence you will have seen headlines like “highest rate in 22 years.” That’s true but as we’ve pointed out, U.S. growth has done just fine with rates at 5% and over, including most of the 1960s and 1980s. There’s nothing particularly startling about the level except that it’s risen so fast from 0% in less than 18 months. We’d also note that with headline inflation at 3%, the real Fed Fuds rate is around its long-term average.

Chair Powell is keeping his options open. When asked about possible rise he resorted to the “if the data warranted” but also that “it’s possible we would choose to hold steady”. The next meeting is not until September and before then we will have two sets of jobs and inflation reports. We think the Fed is done. We’d point out that a year ago, the futures market thought the Fed Funds would be 3.13% now and here we are at 5.50%, so it’s best not to place too much faith in some of these indicators.

More important, fixed income markets barely moved.

They did, however, react to the first report of Q2 GDP which came in at 2.4% compared to an expected 1.8%. Normally, if we see a surprise like that the usual suspects are inventories (because they’re very volatile) or trade (because the numbers are an estimate). But this time the outlier was nonresidential fixed investment. That’s things like transportation (mostly aircraft) equipment and real estate. They were up nearly 1%, the highest rate in over two years. Part of our thesis is that companies are in a multiyear phase of onshoring, and capital investment both of which should lead to better productivity. So, it was good to see those numbers up.

It was also good to see that the price deflator, which is a very broad price measure that no one really targets, was 2.2% compared to 4% in the previous six months and 9% a year ago. Another sign that inflation is heading in the right direction.

We normally take the first GDP report with a pinch of salt as much of the data isn’t in yet. Still, the first look is good.  

Stocks are still in earnings season and it was a good week for the some of the big tech or “Magnificent 7” stocks (Apple, Microsoft, Tesla, Google, Meta, Nvidia and Amazon). The films were better. But Wall Street is rarely original.  

The Dow Jones Index went up 13 days in a row which matches its record winning streak from 1987. It’s not a great index for measuring stock market performance but it does have the advantage of going back 127 years.

So, cue our excuse to pull out one of our favorite long-term charts which shows the Dow pushing ahead through 123 years of bad news. A very hypothetical $10,000 investment made on January 1st 1900, would now be worth $8.7 million! Unfortunately, you can’t buy the index.

Source: FactSet 7/27/2023

A very hypothetical $10,000 investment made on January 1st 1900, would now be worth $8.7 million! Unfortunately, you can’t buy the index.

Subscribe below for our investment updates.

Art: Petra Cortright

Please read important disclosures here.