The Days Ahead:

  • Fed meeting and Inflation.

This Week:

  • The aftermath of the debt ceiling
  • No real impact on growth or debt
  • The Treasury General Account is suddenly popular
  • It’s a reserve balance/liquidity/financial plumbing thing
  • But we don’t think it will have much effect on rates or markets
  • Stock market growth this year is concentrated…
  • …but it’s not a concern
  • Our parting shot on the debt ceiling; see you in January 2025

The Debt Ceiling Aftermath

Thankfully the debt ceiling was suspended until January 2025 with the passing of the Fiscal Responsibility Act of 2023. It was introduced by the House on May 29th 2023 and passed into law on June 3rd 2023. The “X-Date,” when the U.S. would be unable to repay a maturing Treasury bill, was June 5th, 2023. So, we made it. A win for partisanship (no writing in on that one).

 It’s not the fastest bill to clear all three hurdles of the House, the Senate and the White House but it was close. The fastest was probably the amended Emergency Economic Stabilization Act of 2008, which passed in three days, albeit under very stressful circumstances. 

We won’t try to recap the last few months except note that the whole process, while tedious and expensive, left most capital markets unscathed. Other than the short-term bill market, which saw yields rise quickly for bills maturing in June, bond, stock and foreign exchange markets were relatively unchanged. Perhaps we’re all jaded every time the debt ceiling problem comes round. Still, it’s over. We’d note a couple of items.

  • The debt ceiling is suspended not raised. That means there’s no number between now and January 2025 where we will see the debt limit breached.
  • The macro impact is limited. It was much greater back in 2011 when there were immediate cuts equivalent to 0.5% of GDP and another 0.9% negotiated from 2011 to 2013. This one is, at most, 0.4%, assuming all of the $1,300 billion in cuts over 10 years in enacted.
  • In government speak, a cut is not what you and I would call it, meaning we must spend less. In the Congressional Budget World (CBO), a cut, or saving, is simply the amount that will be spent compared to the amount that was budgeted to be spent. So, if there’s $1 billion slotted for, say the Food and Safety Inspection Service in 2023 that was budgeted to rise to $1.2 billion in 2024 but has now been revised to $1.1 billion, that is a “cut.” Voilà. Even though it went up 10%.
  • Under the CBO’s estimate for the impact of the bill, budget outlays rise 60% in the next 10 years, or 4.7% a year. In no year does spending drop, either in real or nominal terms. The total savings in the next two years are around $170 billion, during which time government expenditures, which include transfer payments like Social Security, will be $18,264 billion and GDP will be around $54,561 billion.
  • The cuts are not enforceable after 2025. At that point, Congress would have to accept the caps, or not. If history is a guide, it won’t.

Any forecast on changes to GDP must be riddled with caveats, if only because all spending levels probably revert to normal in two years. But most people think it will trim 0.2% in 2024 and 0.1% in 2025. Typical GDP revisions are frequent and often exceed that amount, so we’ll say with some confidence that growth, inflation, employment and rates will have a much larger impact on GDP than the recent debt negotiations.

But We Do Have to Mention the Treasury General Account (TGA)

The TGA is held at the Fed. It’s part of the deposits it holds for all banks. This used to be a small number because it was mandated, not excess, reserves that banks had to keep at the Fed and which paid no interest.

This changed in 2008 when the Fed sought greater control over where bank reserves were held and meant banks did not have to forego yield or try and broker reserves into more risky accounts, say an overseas bank looking for funding. Originally, the Fed paid a rate equivalent to the fed funds rate less 0.75% on excess reserves. Required reserves paid zero.

In 2008, they changed it to fed funds less 0.35% and then later in the year to fed funds plus 0.25%.

You can see where this is going. In 2015, it was raised to 0.50% and the excess and required rates were merged. Thus, the Interest on Required Reserves (IORR) and the Interest rate on Excess Reserves (IOER) together became one single rate or Interest on Reserve Balances (IORB).

In 2021, this became even better when the Fed provided a rate on IORB independent of the fed funds rate. They announce the rate every Fed meeting and today it’s 5.15%, a little above the mid-range of the fed funds.

So, back in 2008 banks kept their reserves away from the Fed, in order to earn interest. The Fed now pays them 5.15%. As you’d expect, every time the Fed made the reserves rate more attractive, banks deposited more of those reserves at the Fed.

Source: FactSet

The key dates are 2008, 2015 and 2021 when the Fed made it successively more profitable for banks to park reserves at the Fed. This was also part of the Fed’s plan to give the banks a place to put money during the full-on quantitative easing (QE) days. If the Fed hadn’t provided the IORB rate, banks would have bought bills and driven rates to below the Fed’s target of zero.

The line rose sharply in 2020 and 2021 not only because the Fed was paying good rates but because the various stimulus plans went straight into people’s bank accounts. They didn’t spend the aid and support dollars straight away, which meant bank reserves went up. And, as we know by now, banks got a good deal and sent those reserves over to the Fed. For most of 2022 and into 2023 the IORB was the best overnight rate around and frequently 0.5% above even a 1-month Treasury bill. No wonder balances went up.  

This is where the TGA comes in. The TGA is just the Treasury’s checking account and it holds that money at the New York Fed. And because the Treasury doesn’t immediately need all the money it receives in taxes (say a big income tax payment comes in on April 15th but social security checks are not due for another two weeks), it keeps a balance at the Fed. Just like a bank.

This is what is going on with the TGA, which, again is part of the total reserve balances in the chart above.

Source: FactSet

Yes, it’s fallen. The first big drop was in 2021 when government spending ramped up but as the Covid-19 relief programs expired at the end of 2021 and spending decreased, the TGA balance went back up. For the last 12 months, it’s fallen all the way from $800 billion to $48 billion because the debt ceiling prevented the U.S. Treasury from issuing any more bills. The Fed reports those numbers weekly on a Wednesday but you can also see them daily over at the Treasury. The latest number on Friday was $22.9 billion, which would put it at its lowest since, well, ever because prior to 2013 it was just the plain old Federal Reserve Account.

By Wednesday, it was back up to $71 billion because the Treasury sold some bills earlier in the week.

Now, the market expects the Treasury to rebuild the account to something more like $500 billion. The current bill market, which are any securities with a maturity of one year or less, is about $3.9 trillion or 16% of all debt. The Treasury would like it to be around 20% which implies there’s around $980 billion of new bill issuance coming. The worry is that this will raise rates at the short end and drain liquidity.

We don’t think so. Why?

First, that $980 billion is gross, not net, issuance. The Treasury issues and redeems bills all the time and while it is expected to borrow $726 billion this quarter the net amount will be far less. If the Treasury rebuilds the TGA to say, $500 billion, that’s a very manageable amount for a Treasury auction system that raises over $180 billion a week.

Second, the first 6-month bill offered after the debt bill was on Tuesday for $58 billion at 5.4% with a tendered ratio of 3.1 times. This measures how many offers there were against how much was sold. Think of it as a popularity contest. The higher the number the more popular the bill.

Also, indirect bidders, which is the Treasury’s way of describing people who really want the bill, not dealers who will sell it on, were 62% of the total. A month ago, those numbers were $48 billion at 5.1% with a tendered ratio of 2.8x and indirects at 60%. In other words, there’s no sign of stress at all.

Third, there’s a good likelihood that money to buy bills will come from Money Market Funds (MMF). There is $5.4 trillion parked in MMFs, up $1 trillion in the last six months. Of that total, $2.1 trillion is at the Fed in overnight reverse repurchase (RRR) agreements. This allows MMFs to provide cash to the Fed and receive Treasuries overnight. For that privilege the Fed pays the MMFs 5.05%. It’s very probable that, with the debt ceiling sorted, those MMF will just buy regular bills and stop using the RRR window.

A MMF manager will thus soon face the decision:

A: Park money with the Fed overnight at 5.05%


B: Buy a 3-month bill at 5.3%.

If enough MMFs choose “B”, there will be more liquidity in the system and no real effect on the TGA rebuild. If they choose, “A”, then banks will buy the new bills and there will be less liquidity in the system which is, sort of not great for risk assets.   

We think it will be both with no real effect on liquidity. But there are estimates out there that it will lead to problems.

Finally, we don’t subscribe to the idea that new bill issuance means less liquidity which means stocks weaken. Here we’ve just taken the TGA account and marked up when there were big changes and what stocks did. It’s a bit crude, sorry.

Source: FactSet

The quick version is that in previous run-ups in the TGA, stocks did just fine. When the TGA was depleted in 2021, they also did fine. They were weak in 2022 when the TGA ran all the way down but rates and inflation drove stock market returns. No one in 2022 looked over at the TGA and said, “Oh, look stocks are headed south because the TGA balance is falling.”

Thanks for keeping with that. The quick version is, yes, the TGA will go up and Treasury will issue more bills. But that alone will not be a drag on stocks. Some of those bills will be bought by MMFs, some by banks. But the labor market, inflation and rates will drive market sentiment. The TGA is just financial market plumbing.

Should We Worry About Stock Concentration?

No. The S&P 500 is up around 11% this year but the average stock is up 2.1%. A quick way to look at this is to take the standard S&P 500, which is market cap weighted, and compare it to the S&P 500 Equal Weight where all 500 stocks are given the same 0.2% weighting. Here we’ve put the two together along with the tech-heavy Nasdaq 100 index:

Source: FactSet

The market cap weighted S&P 500 is up around 11%, excluding dividends, while the equal weight is up 2.1%.

The top 10 stocks in the S&P 500 now account for 33% of the total market capitalization of the index and 17% of earnings. So far this year, the Big 8 tech firms of Amazon, Tesla, Nvidia, Google, Meta, Microsoft, Netflix and Apple are up between 38% and 168%. Apple alone is worth more than most national stock markets and more than the S&P 600 universe of small cap stocks.

So, big tech companies won. What else?

Some 391 companies of the S&P 500 underperformed the average rise in the index and the largest quintile of companies accounted for 72% of the total market value and were worth $27 trillion. The bottom 100 were worth just over $1.0 trillion.

Source: FactSet

It not just a tech story. We looked at the “Next Gen” of Nasdaq stocks, which is the next 100 biggest stocks listed on the Nasdaq and has 41% in tech, as against 64% for the main Nasdaq. It’s up only 6% for the year. Again, it comes back to being a very focused and narrow market lead among specific tech companies.

Just to press the point, there’s also this:

Source: FactSet

This is the 3-month performance difference between the cap and equal weighted S&P 500 indexes. If the line is above zero, the cap weighted index is doing better than the equal weight. If the line is below zero, then equal weight wins. You can see on the far right that cap weighted has done very well and is at a record level over the equal weight. Last Friday it peaked at 10.7%. Some of that reversed this week, with the latest number dropping to 8.9%.

However, we’re not that concerned about the dominance of a few stocks. Here’s why.

One, this all is very impressive but many of these stocks had a bad 2022 and so are clawing back a year’s worth of underperformance. Yes, Nvidia is up 164% this year but it’s only up 13% from its 2021 peak. Google is up 44% but 12% below its peak. Meta is up 125% but 30% below its peak. This is perhaps no more than recovery from oversold positions.

Two, narrow markets are unreliable indicators. Sometimes they end up with the top performers retreating, sometimes they end up with the rest of the market catching up. In general, when there’s a clear lead by a few companies, the subsequent one-year returns of the S&P 500 are, well, average.

Three, valuations across the market are very reasonable. Most estimates for S&P 500 earnings in 2024 are around $245, putting the market on a 17 times multiple. Some 346 of the companies expect to show increasing or flat earnings in 2024. The valuations on the big movers, however, are much higher with Nvidia selling at a staggering 52 times earnings and 37 times sales. There are a lot of hopes and dreams tied up in that stock.

Four, part of the run up in the Big 8 is the Artificial Intelligence or AI theme. This is probably real in the same way that internet of things, Web 3.0, big data, Bitcoin, blockchain, gamification, virtual reality, augmented reality, connectivity, 3D Printing, autonomous tech, genomic revolution, fintech payments, and machine learning are real and are, or were, all important. We’ve seen pages written about how AI will put journalists, programmers, scriptwriters, accountants, customer service representatives, translators, paralegals, analysts, photographers, market commentators (surely not?) and designers all out of a job. Possibly. But then tech breakthroughs tend to create other jobs. Perhaps with a lag and often with disruption. One function is displaced and another source of income arises.

We’ll just stick with the optimistic view that tech innovation is fast. Early winners sometimes take all and sometimes pioneers end up stumbling.

It’s at times like this that we pull out the long-term charts.

Source: FactSet

This is the Nasdaq price return compared to the total return (i.e., it includes dividends) of the S&P 500 Equal and Market-Cap weighted index. Clearly Nasdaq wins hands down.

Except that after its peak in 2000, it took 15 years to regain the same level. And it’s very volatile.

The Equal Weight S&P 500 has done better than the Market cap S&P 500. But most of that was in the pre-GFC market lovefest with financial stocks. Since 2012, the cap weighted index has done better, and it’s done better since 2021 and, of course, this year.

Our conclusion? No one investment strategy wins hands down all the time. Diversifying seems to work.

So, our takeaway is that some companies are expensive but the market is not and it probably pays to be careful jumping into the mega caps. The broader U.S. market is a little less exciting right now but there’s no reason why it can’t move up.

Debt Ceiling

You’re not going to write about the debt ceiling again, are you? No. Well, except this:

Source: FactSet

Credit default swaps (CDS) received a lot of attention during the debt ceiling talks and prices climbed to a high of 175. This simply meant that if you paid $1.75 for every $100 of a Treasury bond you owned, you would be made whole if it defaulted. It made for a good headlines and we sort of went along with it. But the notional amount of CDS was never more than around $5 billion for a $31 trillion market. It was very small beer compared to what was going on. It was also like a cheap lottery ticket. If it worked, you stood to make 28 times your money. If it didn’t, you stood to lose not very much. In other words, it was an easy-to-understand measure that received more attention than it deserved.

Anyway, CDS prices are now down to 12, which is more than Germany (3.4), Japan (3.5) but less than Greece (19) and Russia (13,775). So, we’ve got that going for us, which is nice. But it tells you more about the weird world of CDS prices than sovereign default risk.

The Bottom Line

We wrote about the S&P 500 Equal and Market Cap Weighted discrepancy earlier in the week and, hey, presto, the gap narrowed. That above chart is now 7.9% from 10.9% a week ago. That means the market breadth opened up with the S&P 500 up 0.6% and the Equal Weight up 3.3% for the week. Small and Mid-Cap stocks also had a good week, rising 6.6% and 5.4% (we use the S&P indexes not the Russell ones). That’s a nice change from prior weeks.

What happened? Not much. It was a light data week but weekly unemployment claims rose more than expected and inventories and the trade number fell more than expected. The last two feed right into the GDP number so it’s more sign of a cooler economy. The claims numbers are very volatile. A few weeks ago, we saw a big number but it turned out to be fraudulent claims in Massachusetts. This week, it may be off because of the California dockers’ strike. Still, at 261,000, it was the highest since October 2021.

The slow down, at least relative to expectations, was enough to lead to a rally in the 10-year Treasury down to 3.7% and for the market to think about lower rates. We’d caution that in a slow data week, the market can take on a life of its own. We’ll know more next week with an inflation report and a Fed meeting.

European stocks haven’t done much since early April but they are up around 12% this year and have held on to their gains despite a revision down in first quarter growth.

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Art: Mickalene Thomas (b 1971)

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