Little Visible Progress on the Budget Shutdown, but Some Inside Baseball In Play

Wardwell’s Weekly Market Report

Observations on the Capital Markets – Week Ended October 4, 2013

  • Little visible progress on the budget shutdown, but an important positive development on the debt ceiling goes almost unnoticed
  • Last week in the capital markets: a quiet week
  • U.S. economic data: the economy was still growing when the government shut down
  • But the data wasn’t entirely upbeat
  • Non-political Europe watch: the “weak, fragile and uneven” recovery continues
  • U.S. pension watch: ERISA worked
  • Congress can—and should—raise the debt ceiling before addressing the budget. Boehner’s outlet.

Little Visible Progress on the Budget Shutdown, but an Important Positive Development on the Debt Ceiling Goes Almost Unnoticed

President Obama canceled his planned visit to Asia and participation in the Asia-Pacific Economic Cooperation summit—citing the inconvenience caused by the government shutdown (“the difficulty in moving forward with foreign travel in the face of a shutdown), sending John Kerry in his place, and reiterating his unwillingness to negotiate with Republicans.

House Speaker John Boehner is reportedly prepared to break the “Hastert Rule” to raise the debt ceiling. Inside baseball:

  • The so-called “Hastert Rule” is an informal governing principle whereby the Speaker of the House does not allow a vote on a bill unless a majority of his party supports the bill—unless it “pleases the majority of the majority.” In practice a discharge petition signed by 218 (or more) members (from any party) can force a vote (218 is the number of votes needed to pass a bill). However, discharge petitions are rarely successful, as congressmen are generally reluctant to challenge their party’s leadership.
  • The Hastert rule is what gives the “Tea Party” its blocking power in the House: more than half the House Republicans are on board.
  • As stated in Pirates of the Caribbean, however, it’s more of a guideline than a rule. Boehner has violated it four times, most notably for the fiscal cliff (tax) bill at the beginning of 2013—which passed with only 35% of Republicans and 90% of Democrats voting for it.

As I noted last week, Speaker Boehner might get passage of either a continuing resolution or debt ceiling increase, but to do so would risk an intra-party revolt that costs him the Speaker role. By signaling that he will not let the “Hastert Rule” lead to a debt default, Boehner could be telling the Tea Party to pick its battle elsewhere (e.g. the budget battle).

Last Week in the Capital Markets: A Quiet Week

Bonds: The 10-year Treasury’s yield raised 2 basis points (bps) to a yield of 2.66%; the 10-year TIP (Treasury Inflation Protected) yield was flat at 0.46%. The yield spread of High Yield bonds over Treasuries as measured by the Merrill Lynch High Yield Master II Index narrowed 5 bps to 477.
Equities: In the regional MSCI indices and the S&P 500, Emerging Markets and the S&P 500 were essentially flat for the week. Within the S&P 500, Health Care and Materials led; laggards were Industrials (a leader last week), Consumer Staples, and Utilities. MSCI Europe declined less than 1%. MSCI Japan was up over 10% in late September, reversed direction, falling almost 5% last week.
Commodities: Oil was up about 1%, gold was down about 2% (even with the dollar being weak against most currencies). The Wall Street Journal reported that the U.S. is overtaking Russia as the world’s largest producer of oil and natural gas.
Currencies: The dollar was broadly weaker by approximately 1% against a broad range of currencies on rising expectations that Quantitative Easing (QE) will not be tapered in October. (Even the Indonesian rupiah stopped falling.)

U.S. Economic Data: The Economy Was Still Growing when the Government Shut Down

  • The ISM manufacturing report rose for the fourth consecutive month, reaching 56.2 in September. Both new orders and coincident readings were strong. The (newer entrant, shorter track record) Markit US PMI manufacturing index faded slightly in September, from 53.1 to 52.8; its new order element was weaker than the ISM’s.
  • The Dallas Fed district manufacturing report and the Chicago and Milwaukee PMI reports were solid.
  • Initial unemployment claims (308,000) stayed low; the 4-week average (305k) hit a new cycle low.

But The Data Wasn’t Entirely Upbeat

  • The ISM non-manufacturing index faded from 58.6 to 54.4 in September (disappointing, if still above 50). New orders, especially export orders, were strong, but other indicators pointed to slowing growth.
  • The ADP private payroll report showed weaker-than-expected payroll growth in September and the August number was revised downward. While the correlation is imperfect, it suggests Friday’s monthly job number (not reported due to the shutdown) might have disappointed.
  • Auto sales were surprisingly weak, though still up 3.4% year over year and still above the 15 million units/year pace.
  • Purchase mortgage applications fell last week; for the past month, they are essentially flat.

Non-Political Europe Watch: The “Weak, Fragile and Uneven” Recovery Continues

  • Private sector business activity across the Eurozone improved in September, with a composite output index hitting a 27-month high of 52.2.
  • The European Central Bank, seeing conditions evolving in line with its forecasts (Draghi called the Eurozone’s economic recovery “weak, fragile and uneven,” credit growth remains weak and inflation remains low), maintained its policy stance: rates at or below present levels for an extended period of time.

U.S. Pension Watch: ERISA Worked

  • This week a Mercer report estimated that the corporate pension plans of the Standard & Poor’s 1500 were 91% funded last month.
  • Last week, a Wilshire Associates analysis of 106 city and county defined-benefit pension plans showed funding fell to 69% last year.
  • Comment: it’s too bad the government exempted government pension plans from ERISA.

Congress Can—And Should—Raise the Debt Ceiling Before Addressing the Budget

The debt ceiling can be raised before the budget is done. The order in which they’re addressed is flexible. Boehner might have found a viable strategy: the House could pass a (relatively) clean debt ceiling increase while continuing to dig in its heels in the budget battle. The Senate and president wouldn’t reject/veto a (relatively) clean debt ceiling increase. This would eliminate the risk of default on the debt, a cut-off of entitlement checks, etc., but the shutdown of “non-essential” Gov’t functions over Obama care would continue. The Tea Party would still be holding a gun to the head of the government, but not to the head of the global economy.

Data Sources: The Wall Street Journal, Financial Times, Bloomberg.

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