Markets Drift Lower While Debt Ceiling Theatrics Wait in the Wings

May 12th, 2023

Markets Drift Lower While Debt Ceiling Theatrics Wait in Wings

Below is a summary of the news and events driving the market and the economy over this past week.

Regional Banks Continue to Unnerve Markets: Stocks struggled to move higher for the second consecutive week as investors weighed regional bank concerns against a mixed economic outlook. PacWest Bank, short traders’ latest target, dropped -22% on Thursday as it reported deposits for the week ending May 5th fell -9.50%, reigniting concerns of another depositor bank run. Phoenix-based Western Alliance also garnered headlines, ranking high on short sellers’ lists as it too saw large deposit outflows in March when the banking crisis first emerged. While Western Alliance’s bank deposit flows have since stabilized, investors remain wary.

Inflation Still Too Strong for Comfort: April CPI data showed mildly moderating conditions for inflation-weary consumers. The CPI Index eased to 4.90% on an annual basis, sparking optimism from investors that the worst of inflation is now behind the economy. That figure is down sharply from the 9% reading posted nearly a year ago (June 2022). Month-to-month, however, prices were higher by 0.40%. The increase was driven by rising shelter, used vehicle, and gas prices. Core prices, which exclude volatile food and energy, remain highly problematic, however. Core rose 0.40% month-to-month and 5.5% from a year ago. This is sure to catch the Fed’s attention. The cost of shelter was up 8.10% from a year ago, while strong demand for used cars reversed recent declines, pushing used car prices up 4.40% for the month alone. “Super core” inflation, which excludes food, energy, and shelter, also remained sticky in April posting a 3.70% increase from a year ago. Some good news for consumers could be on the way based on the producer prices report, however. Producer prices rose 0.2% in April and were up just 2.30% from a year ago. That was its smallest annual increase since January 2021. Core PPI, which excludes food, energy, and trade services, rose 0.20% in April as well, bringing the annual increase to 3.40%. The moderation in pricing at the producer level should help ease consumer prices in the coming months.

U.S. Debt-Ceiling Impasse Has Yet to Cause a Stir:  Markets have shown remarkable constraint over a potential federal default that could come as soon as early June. While both sides are playing a high stakes game with the U.S.’ creditworthiness, it is one that has been played nearly eighty times since 1960. Many of these debates have come down to the wire and in a half-dozen cases, the foot-dragging has forced the Treasury to utilize creative techniques to find the necessary liquidity to avoid default in the interim. Markets seem to have anticipated the drama this go round but are betting the matter will get resolved before any real damage is done. Is Congress really dumb enough to raise interest rates on itself by defaulting? Maybe don’t answer that question.      

Parting Thoughts

Markets may have fallen slightly for the second consecutive week, yet remain remarkably calm. Yes, you have the debt ceiling sideshow that could soon move center stage and a regional bank “crisis” carousel that’s still revolving, but those concerns have been countered — at least to date — by a better-than-expected earnings season and cooperative economic data. Coming into the year, earnings were expected to fall -7% in the first quarter. With 92% of the S&P 500 constituents having now reported, aggregate earnings have only declined -2.5%. Markets have also benefitted from a combination of decelerating pricing data and a softer tone from the Fed.  The regional bank “crisis” continues to be responsible for a great deal of the reactionary or momentum trading day to day, but the market seems to have relegated the “crisis” to that of a non-fundamental concern having now seen a few variations from the Fed’s rescue playbook. This leaves the debt ceiling debate as the biggest near-term catalyst for investors to watch. Since both parties are using default as their fulcrum, we would not expect a resolution on this matter prior to early June when the U.S. is expected to run out of cash, according to the Congressional Budget Office. Get ready to hear the words “catastrophic” and “unprecedented” a lot over the coming weeks. If the U.S. does indeed default, catastrophic is probably a pretty good adjective. Not only will the markets have a heart attack in the short term, but government borrowing rates are going to be much higher well into the future. Investors will punish the U.S. by incorporating a risk premium for the government’s dysfunction. As for whether a U.S. default would be “unprecedented,” that is a matter of debate. The U.S. government has on at least five other occasions not paid investors back – at least not paid them back on the same terms on which the bonds were originally issued. In four of these cases (1862, 1933, 1968, and 1971), the U.S. paid investors back in U.S. currency rather than the gold that the investors were due. In 1979, amidst a debt-ceiling debate, Congress remained deadlocked until the very last moment but ultimately approved the ceiling’s increase. Unfortunately, the Treasury was not technologically prepared, and due to logistical problems was unable to process checks and complete a treasury auction in time to prevent a temporary delay in payments to investors. The event caused T-bill yields to spike and remain elevated for months – to the expense of the taxpayers.  In summarizing this same event in 2013, Mathew O’Brien, a former senior associate editor at The Atlantic, wrote: “Once upon a time, Congress didn’t want to raise the debt ceiling, and sent the country into default. It was bad, and we shouldn’t do it again. The end.” In 1979, we ultimately only missed payments on $122 million worth of bills. Today our current debt is $31.4 trillion. Default is truly not an option. The current debt discussion is likely to come down to the wire, but a deal gets done. So far, markets are betting on that, but as the rhetoric ratchets up and the deadline nears, investors should look at any volatility around the event as a longer-term opportunity.

The Week Ahead

Next week, we will take a look at the health of the consumer with retail and existing home sales. 

To Secure and Protect: Keeping Client Data Safe

National headlines in recent weeks included coverage of a ransomware attack on the City of Dallas that knocked the Dallas Police Department’s website offline, and a cyberattack at a university in Montana that resulted in the state’s Army National Guard defensive cyber operations division being sent to assist with resolving the threat. Cybersecurity is a growing concern worldwide as incidents of hacking, phishing, malware, and other malicious attacks grow more prevalent. Probity Advisors, Inc. recognizes that cyber-related threats are omnipresent, and we wanted to assure our clients that safeguarding client data and protecting our clients are a priority.  Below is a partial overview of our cybersecurity risk management initiatives: 

Cybersecurity Protocols and Procedures

• Conduct ongoing risk assessments to identify physical and cyber threats, vulnerabilities, and potential business consequences and utilize risk assessments to improve overall protection
• Manage identities and credentials for authorized devices and users, ensuring password complexity and multifactor authentication
• Monitor connections to the firm’s network and conduct regular system maintenance and updates as they become available or necessary to address any security vulnerabilities
• Authenticate requests for transfers of client assets to identify or prevent anomalous and potentially fraudulent requests
• Maintain a cybersecurity insurance policy
   

Security Technology and Physical Protection

• Employ impersonation protection to automatically inject a warning banner into an email message if an email is received that matches a contact’s name but that comes from an unknown address
• Manage physical access to assets such as servers, office space, and workstations. Servers are protected in a locked data center, and our office is protected with an electronic key card system
• Implement data leak protections including anti-virus software and remote location/wipe enabled, a security feature that enables an administrator to remotely erase the data on a mobile device if the device is lost or stolen
• Protect user devices with full disk encryption which converts data into code to render it unreadable to unauthorized users
• Utilize enforced device lock with password requirements along with a predetermined threshold of local failed authentication attempts to protect mobile devices
• Incorporate secure protocols such as HTTPS (Hypertext Transfer Protocol Secure) and SFTP (Secure File Transfer Protocol)
   

Employee Training and Education

• Ensure employees are familiar with spotting common fraud schemes, including social engineering, phishing, malware, email spoofing, fraudulent transfer requests, and other types of schemes
• Attend compliance education and cybersecurity training and ensure employees attest to company policies and procedures related to data protection
   

Disaster Response and Recovery

• Execute and maintain recovery processes and procedures to ensure timely restoration of systems or assets affected by cybersecurity incidents
• Utilize data back-up to an isolated environment