Latest On Healthcare & Debt Ceiling

The GOP barely passed the motion to proceed with debate on the healthcare bill as John McCain dramatically came back from illness to push it over the edge. There was a snarky hot mic take which ended up being useful as Senator Susan Collins and Senator Jack Reed expressed worry about the lack of discussion on the debt ceiling. The fact that a moderate Republican and a Democrat could agree on the importance of the issue might mean there’s consensus on raising the debt ceiling without attaching any attached changes to spending. From the stock market’s perspective, it wants the debt ceiling to be raised as easily as possible without any controversy. The chart below shows the latest changes in the treasury bill yield curve. In the 2013 crisis, the 6-month to 1-month spread was negative due to debt ceiling worries. Now it is the 6-month to 3-month spread which is inverting. It appears there wasn’t much worry in 2011 despite that being the year S&P downgraded America’s debt. One possibility for that is the market didn’t realize the severity of the partisanship in Congress. Bond traders are now pricing in Congress’s inability to get anything done and the precedent of this being a contentious issue.

It’s impossible to discuss every permutation in healthcare because potentially 100 different versions of the bill will be voted on. One of the most likely possibilities is a “skinny” Obamacare replacement bill that Rand Paul has come up with. Some of the possible parts of Obamacare which might be eliminated in the “skinny” plan are the medical device tax and insurance mandates on individuals and businesses. The votes are expected to tell GOP leadership where everyone stands on each issue. It’s a ‘trial by fire’ approach to get something done. I’ll provide updates on the legislation in the next few days if anything happens. It’s critical that the GOP passes something that lowers spending so it can use that money to pay for the tax cuts. If there isn’t much cost savings from healthcare, the tax legislation will be equally as contentious.

Stock Movement Quiet

Stocks have ignored the healthcare proceedings because it is earnings season. Although Alphabet disappointed, the overall market has performed well as the S&P 500 was up 0.29% on Tuesday. The chart below shows the amazing run the market has been on. The stretch without a 5% correction has reached 270 days which is the 4th longest streak ever. Looking at valuations, in March 1994, the Shiller PE was 20.83, in June 1965, it was 22.39, and in July 1996 it was 24.86. This means the current Shiller PE of 30.32 is higher than the other longer streaks. The VIX remains extremely low as it closed at 9.43. 39 of the 100 lowest VIX closes have occurred this year. The rest of the week will be impacted by Amazon’s (AMZN) earnings on Thursday and Facebook’s (FB) earnings on Wednesday.

Economic News

The consumer confidence report by the Conference Board had a strong reading probably because of the strong labor market and strong stock market. There has been weakness in some other consumer surveys such as Gallup and this one in June. The Present Situation index increased 3.9 points to 147.8. The Expectations index increased 3.7 points to 103.3. The consumer’s outlook on the labor market improved and its outlook on income growth declined slightly. The chart above which shows the lack of a 5% correction in 270 days plays a part in this sentiment improvement.

The other economic report of notable importance was the Richmond Fed manufacturing activity index. It was a good report, in concert with the decent results from the Markit Flash reading I discussed on Monday. The composite index rose from 11 last month to 14 this month. The wage index increased from 10 to 17, indicating the tightness in the labor market has led to cost increases for manufacturing firms. I have been focusing on price inflation to see if the Fed will get a bailout on the inflation front. This report showed flat priced paid and received. There was a modest increase in expected prices paid, but I wouldn’t change my inflation expectations based on this report.

Fed Preview

Tomorrow is the FOMC meeting for July. The Fed is widely expected to not raise rates as the chance of a rate hike is only 3.1%. There’s only an 8.4% chance of a rate hike in September, so it might be a hawkish statement. The meetings with a rate hike this year have been dovish while some without a rate hike have been hawkish. The Fed might decide to acknowledge the disinflation more explicitly which would be very dovish. Most of the media coverage will be on any hints about the coming unwind as it might start in September. The exact start of the unwind is less important than when it grows to a more meaningful level. That being said, the earlier it starts, the earlier it will grow.

If you’re trading the statement Tuesday, the chart below is useful. It shows the stock market has typically rallied throughout the day on FOMC statement days. That chart is from September 1994 to March 2011. In watching the trading on FOMC days in the past few years, I can say that looks remarkably close to what I have witnessed. Rarely does the Fed have a hawkish tone that sends the market lower. The belief that the Fed can save the market from any problems is real. It’s questionable if the market should have such fervent belief in the Fed though.

In terms of what I expect for the discussion on the balance sheet unwind, I don’t think there will be any new details on the process. We know most of what will happen already. The specific details of exactly when it will start might come at Jackson Hole or at the September meeting. As of now, I continue to be more uncertain on ECB policy than Fed policy. I’ve heard a dovish Draghi and I’ve seen predictions that the asset purchases will end mid-2018. Those two must coalesce soon.