Weekly Investment Update (01/20/2023)

U.S. Approaches Debt Ceiling

On Thursday, the U.S. reached its borrowing limit of $31.4 trillion, and the Treasury Department began the use of “extraordinary measures” to avoid a U.S. payment default. The timing of an actual default remains uncertain, though Treasury Secretary Yellen stated it was unlikely to occur before early June. Tax revenues saw a large decline in December while interest costs have simultaneously increased as a result of the current higher interest rate environment. While reaching the U.S. borrowing limit may cause alarm, extraordinary measures have been used over a dozen times since 1985. When extraordinary measures are implemented, the Treasury shifts money around government accounts in order to remain under the borrowing cap; measures could include withholding regularly scheduled contributions to federal employee retirement funds and using that money to continue paying debts. After the debt limit is increased, these accounts are “made whole.”

As we monitor the situation over the coming months, we believe the debt ceiling debate will contribute to noisy headlines and market volatility, but we strongly believe a default will be avoided as the consequences are too high and leaders of both parties have acknowledged that the debt limit must be raised. Still, we expect a prolonged and contentious debate given the currently divided government with both Democrats and Republicans indicating they are not willing to compromise at the moment. Republicans want to pair the increase with non-defense spending cuts. With spending cuts in focus, it is unlikely we will see an increase in the budget for defense spending in the near term. There are various solutions to resolving the debt ceiling issue before default. Democrats and Republicans could reach a compromise, delay the decision when June approaches, or members of the House could force a vote on the floor without the speaker through a discharge petition.

Within Bessemer portfolios, we have incorporated debt ceiling concerns in current positioning. On the fixed income side for short-term investments, we have avoided areas of the Treasury bill market that could be impacted, and we are steering clear of any Treasury bills that will fall close to the “ex-date” as yields around there have spiked in prior debt ceiling battles. We will continue adjusting purchases to avoid impacted dates as the ex-date timing becomes clearer.

December Retail Sales Fall

December retail sales amounted to $677 billion, representing a 6.0% year-over-year gain but also a 1.1% month-over-month decline as goods prices continue to fall and momentum for goods demand weakens. December’s sales drop was the largest in a year and greater than consensus forecasts of -0.8%. Declines were broad based across categories including gasoline stations, motor vehicles and auto parts, department stores, and non-store retailers.

The results offer cover for both inflation hawks as well as doves favoring a faster pause or even a 2023 reversal in interest rate hikes. Pessimistic investors might see a higher recession risk and harbinger of weak growth if consumption is being materially impaired. More optimistic investors may look at the results as fresh evidence that the Fed is indeed on its way to architecting a smooth landing and cooling a key factor that might help tame inflation.

An overall healthy U.S. consumer has been an important element underpinning our view that the U.S. economy is not headed toward a severe recession. If softening sales help facilitate modestly cooler growth in tandem with more benign wage pressures and moderating inflation expectations, the case for the U.S. avoiding a severe recession is supported. It is also important to note that retail sales cover mostly goods, and to some degree weakening retail sales represent the post-pandemic rebalancing of consumer spending to services relative to goods. The retail sales report, alongside a downward surprise of the Producer Price Index (PPI), moved investors to price in a slightly less aggressive pace of interest rate hikes in the months ahead.

Bank of Japan Maintains Accommodative Yield Curve Control Policy

On Tuesday, the Bank of Japan (BoJ) decided against making another adjustment to its Yield Curve Control (YCC) policy after it expanded the trading range for Japanese 10-year bond yields from 0.25% to 0.50% last month. Instead, the BoJ and Governor Kuroda pushed back against market speculation for a more hawkish change to their YCC policy with Kuroda noting that the central bank will continue easing until Japan’s price goal is met. The BoJ committed to “expand the monetary base until the year-on-year rate of increase in the observed CPI exceeds 2% and stays above the target in a stable manner.” While Japan’s core CPI inflation for November of 3.7% is almost double its target, the BoJ does not expect price pressures to persist and instead sees core CPI inflation declining from 3.0% in fiscal year 2022 to 1.6% in fiscal year 2023 as economic growth slows.

As the next BoJ meeting in March will be Governor Kuroda’s last, some market participants continue to anticipate a potential YCC exit this year given the upcoming change in leadership as well as expectations for higher wages. A Reuters survey noted that more than half of large Japanese companies are planning to raise wages this year. Annual wage negotiations between enterprise unions and employers in Japan begin in February or March, which could result in upward revisions to the BoJ’s inflation outlook. However, any substantive policy change for the BoJ will likely be left to Kuroda’s successor.

The BoJ is one of the last central banks to still engage in accommodative monetary policy in an effort to stimulate inflation after years of a low or disinflationary environment. A BoJ shift toward a less accommodative stance could be positive for the yen, which depreciated sharply against the dollar last year, as other major central banks look to slow the pace of their tightening. While a stronger yen could make exports more expensive for Japanese companies, on the other hand, it would ease the cost of fuel and other commodities for manufacturers. Governor Kuroda’s 10-year term ends on April 8, and we will continue to actively monitor for changes in BoJ policy.