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A Very Fluid Environment

What will happen this week?  At the end of last week, equities slipped while bond yields climbed after a reading of long-term inflation expectations rose unexpectedly and a fresh warning on the debt ceiling. 

Long term debt trades on inflationary expectations and according to the University of Michigan sentiment survey, consumers expect prices to rise at a 3.2% annual rate over the next five to ten years, the highest since 2011.

Inflation is a two-part phenomenon; too much money chasing too few goods fearing higher prices tomorrow.  There is a monetary and psychological component.

Are inflationary expectations beginning to become unanchored, a daunting thought given the country’s $31.5 trillion and growing deficit who interest coverage for the seven months of the year was $374 billion, up 40% or $107 billion for the same period last year.  Interest on the debt is projected to be around $650 billion for 2023, up almost 50% from 2022 according to Bloomberg.

As validated by FRB Chair Powell, the deficit and the increase in the deficit is unsustainable, an unsustainability that rises considerably if inflationary expectations become unanchored.

Friday, Treasury Secretary Yellen issued a renewed call to raise the debt limit stating, “If Congress fails to do that, it really impairs our credit rating…we would have to default on some obligation, whether it is Treasuries or payments to Social Security recipients.”

It is generally recognized the Treasury Secretary serves at the discretion of the President and a major responsibility of the Secretary is to sell the President’s economic agenda to Congress and the populace.

The opinion that a default on the debt would be catastrophic is almost unanimous. However, many believe the Treasury secretary should offer some restraint as has occurred in past Administrations.

The credit default (CDS) market is taking the possibility of a US default seriously, the inverse of most other markets.  As noted earlier, the CDS on the UST are now more expensive that those of Greece, Mexico, and Brazil, closing at an all time high on Friday, perhaps the result of statements from both the President and Treasury Secretary.

Will the complacency of the equity and Treasury market soon be shattered?  The VIX, or fear gauge for equities, is still hovering around historical lows.

What will happen this week?  Because of rising inflationary expectations, swaps traders are now pricing in a one in 10 chance there will be another interest rate hike at the next Fed meeting, after odds of close to 100% of a pause and a reduction occurring by September.

The economic calendar is comprised of retail sales, industrial production/capacity utilization, several housing statistics and inventory data.

Last night the foreign markets were up.   London was p 0.48%, Paris up 0.52% and Frankfurt up 0.27%.  China was up 1.17%, Japan up 0.81% and Hang Seng up 1.75%.

Futures are up about 0.4% on optimism that there may be a breakthrough on the debt ceiling debate.  The 10-year is off 6/32 to yield 3.49%.

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Kent Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.