Draghi Won’t Taper?

The bond market gives us a picture of what investors are expecting from policy makers. The chart below shows the bond spreads the riskier European countries are trading at compared to the German Bund. The spreads of these countries, formerly known as the PIGS, have been tightening in the past few months. This buying might be coming from the ECB itself or it might be a signal of the ‘risk on’ trade. In terms of policy, this tightening of spreads forecasts that Draghi won’t taper anytime soon. It will be important to watch these spreads in the coming weeks as we get closer to the ECB’s decision on whether/how much it decides to taper its 60 billion euro per month bond buying program in January 2018.

Debt Ceiling & Healthcare Vote

In terms of American policy, the Treasury bill market helps us understand where the debt ceiling debate is forecasted to go. The market expects the debt ceiling to be hit on October 26th. As you can see from the chart below, this has caused the Treasury bill market to invert as the 3-month bills include the period where the discussion will be heated. The latest prices are a 1.12% yield on the 6-month bill and a 1.17% yield on the 3-month bill. That’s a 5 basis point inversion as it looks more likely that a stress period will result before the ceiling is raised. Congress goes on vacation in August which means the deal will be done in September or October.

The Senate isn’t focused on the debt ceiling as it’s preoccupied with getting something done on healthcare. It was dealt a large blow last week as many of the GOP’s provisions weren’t allowed to be included under a budget reconciliation which needs 50 votes instead of the normal 60. The most important parts which were disallowed by the parliamentarian were 2 provisions to stabilize the insurance market and the rule where consumers must wait 6 months before buying insurance after a break in coverage to prevent people from only buying insurance when they get sick. The latest news is that the Senate will hold a vote on Tuesday on whether to proceed with the motion on the House’s healthcare bill. Whether this passes might depend on if John McCain is healthy enough to attend it.

I think this is a game of chicken where the Senators threaten to not vote for it, but end up supporting it when their feet are put to the fire. It will be interesting to see how the vote goes as it will be close. The fact that the motion to proceed with the bill might not even pass shows the tough odds the bill faces. The goal of this process is to set up amendment votes on repealing parts of Obamacare and then setting up a 2-year window where a replacement plan is negotiated. If this entire process fails, the Senate will try to pass its own bill called the Better Care Reconciliation Act.

As you can tell, not only is the healthcare plan delaying the tax cuts, but also it’s stopping the debt ceiling from being discussed. I’m not sure what to make of the fact that the debt ceiling will be hit in 3 months and no one is discussing it. Does that mean it will be easy to raise it or is Congress playing footsie with disaster once again? With Congress going on vacation next week, some debt ceiling drama in the fall is inevitable.

Capital One Spells Doom?

Looking at the consumer credit market, the Q2 report from Capital One gave us insight into the credit card loan market. The chart below shows how net charge-offs for the whole company are increasing which isn’t a good sign. The net charge-offs rate was 2.67%. For the credit card business, charge-offs were 5.02% which was flat sequentially, but up from 4.02% in Q2 2016. The worst business sequentially was commercial banking which saw a 66 basis point increase in charge-offs to 0.80%

This might be a case of Capital One having specific issues opposed to the consumer credit market rolling over. In the 4th quarter of 2007 when the economy was already in a recession and the financial markets were about to seize up, Capital One’s U.S. cards had a 4.31% charge-off rate and now they’re at 5.11%. The bears are seizing on this issue as a signal of impending doom, but that’s likely mistaken angst. The chart below shows the delinquency rate on credit card loans. This chart is only updated to reflect Q1 data, but unless Q2 was a disaster, it will show much a much lower delinquency rate than in Q4 2007. In Q4 2007 the delinquency rate was 4.60% and in Q1 2017 it was 2.42%. It’s also important not to get scared by the year over year increase in delinquencies because we’re at such low levels now. As you can see, the delinquency rates rose in the mid-1990s without a recession. We’re nowhere near a recession if you look at this metric.

Good Markit Report

As we await the Q2 GDP report on Friday, we got confirmation that July is looking good by the latest Markit PMI report. As you can see from the chart below, the Composite PMI hit 54.2 which is a 6-month high. The Manufacturing and Manufacturing output indexes both hit 4-month highs. According to the Chief Business Economist at IHS Markit, the flash PMI reports are consistent with 2% annualized GDP growth. As I have stated repeatedly, 2% growth is high for this economy which is seeing declining birthrate growth. The optimism in the so-called soft data is long gone which means we can take it more seriously. I’m not saying that optimism is inherently wrong, but when a soft data report is consistent with over 4% GDP growth like the ISM was earlier this year, it can’t be relied upon. Finally, the Chief Business Economist said that this report is consistent with 200,000 job growth per month as the new order inflows were the second highest in the past 2 years.