BlackRock Commentary: Debt ceiling showdown redux

Jean Boivin, Head of BlackRock Investment Institute together with Wei Li, Global Chief Investment Strategist, Kurt Reiman, Senior Strategist for North America and Nicholas Fawcett, Member of the Economic and Markets Research Team, all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

The U.S. needs to soon raise a self-imposed federal debt limit, or the “debt ceiling”, to avoid a debt default. We don’t see fundamental risks from the debt ceiling showdown – with a low risk of technical default and limited chance of a temporary government shutdown. Yet the twists and turns could trigger jitters in markets that have had an extended run higher. Still, we favor looking through any volatility and stay pro-risk over the next six to 12 months. 

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Source: BlackRock Investment Institute, with data from Refinitiv Datastream, September 2021. Notes: The chart shows changes in yields of 4-week Treasury Bill (T-Bill) yields from 28 days before the debt ceiling “deadlines”, or the dates when the federal government exhausts its borrowing in selected debt ceiling episodes. These deadlines are August 2, 2011, Oct. 17, 2013, Sept. 29, 2017. We use Oct. 15 as the projected debt ceiling “deadline” for this year.

 

The Congress has acted to adjust the debt ceiling 78 times since 1960, according the Treasury Department. Over recent decades the debt ceiling has become a subject of intense partisan wrangling. A two-year debt ceiling suspension expired in July, and the Treasury Department said its “extraordinary measures”, or maneuvers to manage cash and debt in order to avoid breaching the debt limit, could run out next month if Congress doesn’t act. So far we have only seen modest movements at the front end of the Treasury yield curve – in line with market reaction ahead of recent debt ceiling deadlines with the exception of 2017. See the chart above. We see today’s unique market dynamics as contributing to the muted signal from the Treasury market. The Federal Reserve’s near-zero policy rate has intensified the hunt for yield, just as the central bank has become a large buyer of Treasuries. In addition, banking regulations since 2008 have helped broaden the buyer base for Treasuries.

Today’s macro environment is very different from previous debt ceiling episodes over the past decade.  An economic restart is underway in the U.S., and inflation pressure has increased amid pandemic-related supply disruptions. We uphold our tactical pro-risk stance as the restart broadens out, and what we call the new nominal – a more muted reaction from central banks to higher inflation than in the past – is also supportive of risk assets. This is in contrast with the debt ceiling showdown in 2011 that triggered a downgrade in the United States’ AAA sovereign credit rating by S&P just as the euro area debt crisis and worries about slower growth kept investors on their toes. It also differs from 2018, when worries about U.S.-China trade tensions and their impact on the economy were flaring up.

How will the debt ceiling showdown affect the prospects of Congressional spending plans? We believe it will unlikely derail the $1 trillion bipartisan infrastructure bill or the Democrats’ proposed $3.5 trillion spending plan on social policy and climate change – key legislative priorities ahead of the 2022 midterm elections. Yet we do expect the $3.5 trillion price tag on the Democratic-sponsored reconciliation package to be scaled down to help ensure the support of party moderates, who have balked at some of the proposed tax increases for corporates and high-earning individuals to offset spending.

We believe Congress will ultimately reach an agreement to raise or extend the debt limit, but likely not until right before the Treasury exhausts its borrowing capacity. That may come in late October or early November, but the timing is hard to estimate due to lumpy Treasury cash flows for Covid relief payments. The good news: Neither political party wants to see a technical default, and there are no calls for substantive spending cuts. Hence we do not believe the debt ceiling represents a fundamental risk to the market. The risk: The timeline to resolve the debt ceiling is tight. Political brinksmanship appears likely, and any miscalculation could lead to a short-lived government shutdown that triggers market volatility.

Bottom line: We expect Congress to ultimately reach an agreement on the debt ceiling, and see the odds of the federal government committing technical default –or violating terms of its debt – as low. Risk assets could suffer temporary pullbacks after an extended run higher, but we favor looking through any volatility and staying pro risk over the next six to 12 months. We recently downgraded U.S. equities to neutral on a tactical basis to fund an upgrade to European equities, as we see the baton of global restart being passed on to Europe from the U.S.; we remain underweight U.S. government bonds.

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Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of Sept. 16, 2021. Notes: The two ends of the bars show the lowest and highest returns at any point this year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are, in descending order: spot Brent crude, MSCI USA Index, MSCI Europe Index, ICE U.S. Dollar Index (DXY), Bank of America Merrill Lynch Global High Yield Index, MSCI Emerging Markets Index, J.P. Morgan EMBI Index, Refinitiv Datastream Italy 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream U.S. 10-year benchmark government bond index, Refinitiv Datastream Germany 10-year benchmark government bond index and spot gold.

 

Market backdrop

The U.S. consumer price index (CPI) showed a slower pace of price increases in August, thanks to a moderate rise in core components and falling prices in Covid-related items such as airfares and car rentals. Yet price pressures appeared to grow in some non-Covid items, suggesting a broadening and more persistent inflationary pressure.

Week Ahead

  • Sept 20 – Canada federal election

  • Sept 21-22 – Fed, Bank of Japan policy meetings

  • Sept 23 – Euro area flash consumer confidence indicator; Bank of England policy decision; flash composite purchasing managers’ index (PMI) for the euro area, U.S. and UK.

Central banks return to the limelight this week amid rising and more persistent inflationary pressure. Yet we do not expect the growing price pressure to lead to an earlier policy rate liftoff from the Fed. PMI data from key developed economies could shed light on the impact of the delta variant surge on activity restart.


BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of September 20th, 2021 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. 

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.


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Notes from the Trading Desk – Franklin Templeton

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what their professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The Digest

Global equities were softer last week, with a few headwinds at play. The MSCI World Index closed the week down 0.8%, whilst the S&P 500 Index closed the week down 0.6%, the STOXX Europe 600 Index was down 1.0%, and the MSCI Asia Pacific Index underperformed, down 1.6%. There were large volumes later in the week with Friday’s “quadruple witching,” expiration of stock options, stock index futures and options, and single-stock futures, which is a huge liquidity event for equity markets. COVID-19 continues to have an economic impact and the resultant supply chain bottlenecks were a focus last week.

Chinese data continue to disappoint, with retails sales the latest datapoint to miss expectations. Commodities were also in focus, as iron ore prices dropped 20.8% last week on news of China reducing steel output. Energy prices were higher through the week, with natural gas prices up again and WTI crude oil prices up 3.2%, adding fuel to the debate on whether price rises are transitory or not. Despite overall market performance, fund flows signalled a risk-on undercurrent, with a big outflow of cash mainly getting reallocated to equities.

Week in Review

Europe

A continuation of the same global themes from the previous week kept European equities subdued last week, as European equities traded lower overall. Both the STOXX Europe 600 Index and the STOXX Europe 50 Index broke through their 50-day moving averages (a key technical indicator) to the downside last week.

Fears of peak growth and central bank hawkishness as well as recent tax hikes to pay for the impact of COVID-19 stimulus measures have all contributed to recent market bearishness. The upcoming German election this coming Sunday (26th September) has garnered more attention. Whilst the latest polls don’t show a clear winner, it is likely the German government will be comprised of three parties for the first time ever, and any coalition negotiations will likely take some time, especially with three parties around the negotiating table. Any prolonged uncertainty could feed into equity and bond markets.

In terms of sectors, basic resources had a tough week, down 7.7%, as iron ore prices plummeted to their lowest level in 2021. The market interpreted falling demand following reductions on steel production in China. Personal and household goods stocks weakened overall, with luxury stocks back under pressure. In terms of outperformers, travel and leisure stocks saw some short covering last week in anticipation of the United Kingdom relaxing travel restrictions. The sector closed up, breaking through its 50 and 200-day moving average resistance levels last Thursday. Energy stocks were higher last week following the rally in oil prices.

Utilities were a notable laggard in Europe, with smaller providers struggling to cope with rising gas prices on the back of lower supply ahead of the colder months. Recent media reports suggest that the Italian, Spanish and Greek governments are prepared to intervene to prevent consumers from incurring crippling energy bills. Bloomberg reported that Italian Prime Minister Mario Draghi was ready to step in again to reduce the impact of rising gas prices. Draghi’s administration had already spent €1.2 billion in the second quarter of 20201 to reduce the impact on consumers, with electricity bills increasing 9% vs. the 20% increase expected before the government stepped in.

Roberto Cingolani, the Ecological Transition Minister, said last week he expects prices to rise by 40% in the third quarter; hence, increased government funding is required. In Spain, the government approved measures to lower bills via temporary tax cuts, limiting the amount prices can rise. Also, Prime Minister Pedro Sanchez said: “We are going to reduce the profits of energy companies and redistribute to the consumers”. The Financial Times reported that Spain would claw back €3 billion in profits from utilities, which sparked a firm response from energy groups. It was also reported last week that the Greek government intends to spend €150 million to reduce energy bills for households through the rest of the year.

In terms of data out of Europe, eurozone industrial output was stronger than expected, up 1.5% on the month in July and up 7.7% year-on-year. Within that data, capital goods jumped 2.7% in July and non-durable consumer goods production was up 3.5%. Reuters also reported that Italy is expected to post its strongest gross domestic product (GDP) growth since 1970, suggesting it may reach up to 6% for 2021.

United States

US equities declined last week as the recent market bearishness continued. The market appeared to be on the lookout for negatives again last week following a long period of equity market strength, which has seen the S&P 500 Index up 18% year-to-date.

The US Consumer Price Index (CPI) print became a focus throughout the week, coming in at +0.30% for August, which was down from July and less than anticipated, offering some mild reprieve for inflation worries. COVID-19-sensitive travel services such as air fares and car rental prices saw a large decline. Inflation in recreation, restaurants and other personal discretionary services saw a slowdown in price increases. Nonetheless, stagflation conversations continued to pick up last week.

Some economists flagged expectations that the Federal Reserve (Fed) will offer explicit tapering hints at this week’s meeting, but strategists also expect monetary policy to remain extremely accommodative. Additional fiscal stimulus has been complicated by Democratic divisions, while any compromise also brings tax risk.

In terms of sectors, like in Europe, energy stocks outperformed (unsurprisingly) last week. For the same reasons mentioned in the Europe section, utilities and materials stocks were also weaker in the United States. There is a nervousness in markets ahead of the Fed meeting. Equities continue to hover near record levels, but options traders are piling into contracts betting that the stock market will fall.

CNN’s Fear and Greed Index is now in “Extreme Fear” territory. In the details, it noted on Friday: “During the last five trading days, volume in put options has lagged volume in call options by 51.84% as investors make bullish bets in their portfolios. However, this is still among the highest levels of put buying seen during the last two years, indicating extreme fear on the part of investors.”

Asia and Pacific

Events in Asia were a clear focus for equity markets last week as slowing Chinese growth, continued supply chain disruption, regulatory action, steel production cuts and COVID-19 cases all garnered attention. As such, the Shanghai Composite Index closed the week down 2.4%, whilst the Hang Seng Index lagged in the region, down 4.9%. Japan’s Nikkei Index continued its recent strength following the recent political shake-up in Japan, up 0.4%.

Chinese economic activity continues to slow. Industrial production in August rose 5.3% year-on-year vs. a 6.4% year-on-year growth in July. Declines in automobiles, steel and mobile telephones were the key drivers behind the miss. Retail sales also missed last week, growing just 2.5% on the year to August, a notable deceleration from 8.5% growth on the year to July. Fixed asset investment rose 8.9% year-to-date, but also missed expectations, consistent with a steady slowing in real estate.

Real estate stocks were a focus last week in Asia after property developer Evergrande defaulted. Authorities in China told major lenders not to expect interest payments due this week on loans, signalling liquidity stress. Standard & Poor’s said the developer’s liquidity access is said to be “shrinking severely”. Yet, recent issues within the Chinese property market have largely been ignored. Gambling stocks were also a focus for a Chinese regulatory crackdown, with some Macau casino stocks losing a third of their value. Macau’s economic secretary said there were still some deficiencies in industry supervision.

In Japanese politics, the Administrative Reform Minister, Taro Kono, remains the favourite to succeed outgoing Prime Minister Suga. According to the latest poll, Kono is the preferred candidate, with 27% support. Support for the Liberal Democratic Party also rose nine percentage points to 48%. The presidential election is scheduled for 29 September. Equity markets remain buoyant following Suga’s resignation and the Japanese Nikkei Index traded at a 31-year high on Tuesday.

Week Ahead

Monday 20 September:

  • UK house prices
  • German producer price index (PPI)
  • US Housing Market Index

Tuesday 21 September:

  • UK public finances and public sector net borrowing
  • Japanese machine tool orders
  • US building permits
  • US current account balance
  • US housing starts

Wednesday 22 September:

  • Eurozone consumer confidence
  • Bank of Japan policy balance rate
  • US mortgage applications
  • US existing home sales
  • Federal Open Market Committee policy meeting

Thursday 23 September:

  • France business/manufacturing confidence
  • Spanish GDP
  • European Central Bank economic bulletin
  • Bank of England policy meeting
  • France/Germany/Eurozone/UK/US Purchasing Managers’ Index (PMI)
  • US initial jobless claims

Friday 24 September:

  • UK consumer confidence
  • German IFO Survey
  • Italian consumer/manufacturing confidence
  • Italian economic sentiment
  • US new home sales
  • Japan CPI and PMI

Sunday 26 September:

  • German federal election

 


Franklin Templeton Key risks & Disclaimers:

What Are the Risks?

All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. Past performance is not an indicator or guarantee of future performance.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 20th September 2021, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction. 

Issued by Franklin Templeton Investment Management Limited (FTIML) Registered office: Cannon Place, 78 Cannon Street, London EC4N 6HL. FTIML is authorised and regulated by the Financial Conduct Authority.


MeDirect Disclaimers:

This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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