GOVERNMENT SHUTDOWN - Key Dates

The Debt-Ceiling Fight "Could Get Ugly" - Key Dates And Implications 09-30-13 Zero Hedge

Even though there is no technical link between the two main fiscal issues – the continuing resolution (CR) and the debt ceiling bill - there is a link in the minds of market participants because prompt resolution of the CR could spell a favorable outcome for the debt limit. On the other hand, a government shutdown tonight could lead the market to be more pessimistic on the chances of a debt default. As BofAML notes, the link between the two issues is fairly complex but the shutdown battle is just the beginning - and, as they suspect "the fight could get ugly."

As BofAML notes,

In Washington, the link is viewed differently, with the House Republican leadership seeing an immediate deal on the CR leaving more negotiating room on the debt limit, but a shutdown having an immediate negative political impact and increasing the chances of a political capitulation on the debt limit. The link between the two issues is fairly complex.

Debt ceiling – paying the bills

The shutdown battle is just the beginning. At the time of this writing, the House decided to delay any action on an initial version of the debt limit extension, with numerous extraneous provisions attached, including a one-year delay in implementing the ACA, the Keystone pipeline, energy policy, financial regulation, and others. These extra provisions could be a basis for giving the Republicans some political cover in passing a debt limit extension.

However, disagreements among House Republicans have delayed this initial vote on the debt limit for at least several days. The president continues to insist there will be no negotiations over the debt limit. The divisions among House Republicans, as well as the relative political weakness of the president, who has seen his approval ratings decline, increase the difficulty of finding a path that would lead to a solution. We expect a solution will be reached before the deadline because the political costs of a debt default would be significant.

Important dates, mechanism of debt ceiling raise

The deadline dates pertinent to the debt limit have been narrowed considerably. The Treasury released an estimate that extraordinary accounting maneuvers allowing public debt issuance at the debt limit would be exhausted by October 17, at the latest. The CBO also estimated that the cash balance would be run down sometime between October 22 and the end of the month. In our view, there are three relevant dates, using our estimates of the path of the debt outstanding subject to the limit and the Treasury cash balance.

October 15 We estimate that the Treasury exhausts its accounting maneuvers on October 15. This date is the settlement of the mid-month coupon auctions, in the 3y, 10y, and 30y maturities. Any uncertainty in the ability to settle the entire auction without breaching the debt limit would require one of three choices:

• delaying the auctions and issuing cash management bills instead,
• scaling down the auction sizes to only roll over maturing issues,
• or auctioning the full amount and scaling down the regular bill sizes ahead of time to create enough headroom,

with the last alternative being the most likely in our view. According to our estimates, this date would be a fairly close call, but maneuvers are certain to be exhausted in the next day or so, with a mid-October payment into the Highway Trust Fund.

After this date, the Treasury would be in rollover mode, issuing just enough at each auction to roll over maturing debt, while paying for outlays using withholding tax revenues and steadily draining the outstanding cash balance. In our view the Treasury may have enough cash balance to make it to the end of the month and make the month-end interest payment, although there is substantial uncertainty.

November 1 Treasury will fail on its scheduled spending obligations on November 1, having almost certainly exhausted its cash balance. A total of $67bn in payments for social security, Medicare, Medicaid, military pay, and veterans programs will be due on this date. After this, the Treasury could only spend money as it comes in via tax revenues, with scheduled payments being delayed or only paid partially. It is uncertain how the Treasury will prioritize spending programs.

November 15 The first large coupon interest payment of $31bn is paid on November 15. If the debt limit is not raised by then, the Treasury is likely to fail to pay bond interest and will be in technical default.

Key Factors

There are four key factors while analyzing possible market implications of the upcoming fiscal debates, in our view.

Higher market sensitivity to fiscal discussions: Given that both Chairman Bernanke (in his September FOMC press conference) and NY Fed President Dudley referred to the upcoming discussions as a risk factor for their outlook, market sensitivity to these headlines is likely to be more than initially anticipated. Tapering expectations priced into the market may change depending on the severity of the outcome.

The fight could get ugly: As our economics team points out, by shifting the focus of the debate to the funding of the ACA (instead of specific spending cuts), the Republicans have found a less politically dangerous strategy. At the same time, President Obama perceives himself in a stronger negotiating position given that he does not face reelection this time, reducing the effect of some of his own declining approval polling numbers and other recent polls that show equal blame adhering to both sides in a shutdown.

The result is unlikely to be near-term fiscal tightening: Given the gradually improving deficits over the last few years, the discussions on the current episode are unlikely to result in near-term fiscal tightening (unlike 2011, which led to the sequester). This is evident in that most Republican proposals no longer attach near-term cuts to spending. Instead, they are focused on health care and entitlement spending.

External factors that affected us in 2011 unlikely to repeat: This episode is unlikely to be of the same scale as the debt ceiling crisis in 2011. At that time, economic data were very weak, the Fed strengthened its forward guidance and was contemplating Operation Twist, European peripheral spreads were widening dramatically, and there was novelty around the debt ceiling and possible downgrades of the US sovereign credit rating. None of these one-time factors are in play this time.

Even though there is no technical link between the two issues, there is still a link in the minds of market participants because a government shutdown next week may lead the market to be more pessimistic on the chances of a debt default.

While comparing the market reactions from 2011, we caution investors to be aware of certain key differences. There was a novelty to dealing with the ceiling in 2011. The US in recent history had not experienced such a bitter showdown on whether to pay the nation’s bills, and markets likely had greater uncertainty premiums.

GOVERNMENT SHUTDOWN - The Next Step In The Collapse Of The Dollar

Government Shutdown: The Next Step In The Collapse Of The Dollar? 09-30-13 Brandon Smith of Alt-Market blog, via ZH

There is a considerable amount of debate in alternative economic circles as to whether a federal government shutdown would be a “good thing” or a “bad thing”.  Frankly, even I am partially conflicted.  I love to read mainstream news stories about how a shutdown in the capital would be “horrible” because Barack Obama might have to reduce the White House cleaning staff and wash his own laundry:

http://www.bloomberg.com/news/2013-09-27/obama-stripped-to-skeleton-staff-in-a-government-shutdown.html

It's about time that sellout bastard did something to clean up his own act.  I also love the idea of the federal government out of the picture and removed from the U.S. dynamic.  Americans need to learn again how to live without the nanny state, even if only for a few weeks, and what better way than to go cold turkey.  I can hear the tortured sobs of the socialists now, crying for their SNAP cards and low grade government healthcare.  It's like...beautiful music...

That said, as much as centralized government needs to be erased from the face of the planet, there are, indeed, consequences that must be dealt with.  It is foolish to believe otherwise.  No social system, and I mean NO SOCIAL SYSTEM, changes without pain to the population.  I am not among those that cheer a federal shutdown, because I understand that the only people to ultimately feel suffering will be average citizens, not the establishment itself.  The sheeple may be ignorant and blind, but no one deserves the kind of unmitigated hellfire that could rain down upon our country if a shutdown continues for an extended period of time.  Call me a humanitarian...

As I write this, mainstream media projections estimate a 90% chance of government shutdown by midnight on September 30th.  Though technically, government funds will not run out until October 17th:

http://www.usatoday.com/story/news/politics/2013/09/25/treasury-debt-limit-october-17/2867471/

We have dealt with this kind of talk before over the past few years, and it's interesting to see the kind of cynicism that has developed over the idea of a shutdown event.  After all, the last time a government shutdown occurred was at the end of 1995, lasting only a couple of weeks into 1996.  The GOP has folded so many times over the U.S. budget and debt ceiling that most of the public expects they will obviously do it again.  It is certainly possible that the Republicans will roll over, however, I am not so sure of that this time around.  Why?  Not because Obamacare is on the table.  Obamacare is just a distraction.  No, I'm far more interested in the circumstances surrounding the U.S. dollar. 

Obamacare is designed to fail.  Anyone with any financial or mathematical sense could look at the real national debt and deficit projections of the U.S. and understand that there is no money and never will be enough money to fund universal healthcare.  The GOP could simply let the program take effect, sit back, and watch it crash and burn over the next three to five years.  This would entail, though, watching the whole of our economy crash and burn with it. 

What we have developing in front of us is the recipe for a new false paradigm.  Already, the MSM is discussing the possibility of debt default and who will be responsible under such circumstances.  Not surprisingly “Tea Party” conservatives have been named the primary culprits if a shutdown goes south; even former Democratic president Bill Clinton is getting in on the blame game:

http://abcnews.go.com/blogs/politics/2013/09/bill-clinton-when-it-comes-to-obamacare-gop-begging-for-america-to-fail/

All the bickering over Obamacare is fascinating, I'm sure, but lets set the Affordable Care Act aside for a moment and look at the bigger and more important picture.  The private Federal Reserve Bank has just announced to much surprise a complete reversal on its suggested QE “taper” measures, resulting in a shocked and confused marketplace.  If the U.S. fiscal system is stable and sound, as the Fed has been suggesting for the past year, then why continue stimulus measures at all?  Could it be that most if not all positive economic numbers released by the Fed and the Labor Department are actually fake, and that investors have been duped into assuming overall growth when America is actually in an accelerated decline?   Wouldn't that be a high speed excrement storm straight out of left field!

The first day rally over the Fed announcement faded quickly, resulting in a slow bleed of the Dow ever since.  The magic of Fed stimulus is wearing off, and the investment world is not happy.  If I were a member of the Federal Reserve Bank, I suppose I would appreciate a large scale distraction designed to take attention away from me and my elitist club-mates as the primary culprits behind the greatest currency implosion in the history of the world.

Sadly, a government shutdown is sizable threat to the American financial system, and few people seem to get it.  Perhaps because the expectation is that any shutdown would only be a short term concern.  And, this assumption might be correct.  But, if a shutdown takes place, and, if “gridlock” continues for an extended period of time, I have little doubt that the U.S economy will experience renewed crisis.  Here's why:

Exponential Debt

Obamacare only tops a long list of already existing “unfunded liabilities” (otherwise known as entitlement programs).  These programs are not counted in the government's official calculations of national debt or deficit spending, but they cost taxpayers money all the same.  True deficit costs and national debt costs expand every year without fail.  If the debt ceiling does not rise in accordance with this exponential debt, a default is inevitable.  No amount of increased taxes could ever fill the black hole already created by negative government spending. 

A long term government shutdown will eventually require cuts in entitlements, if not a total overhaul of certain aid programs.  Imagine an end to all disability payments, including veterans disability payments.  Imagine federal employee pensions put on hold for an undesignated period of time.  Imagine food stamps placed on hiatus for 50 million people.  Imagine how many states now rely on federal funding just to keep municipalities from bankruptcy.  Get the picture now? 

End Of Foreign Faith In U.S. Treasuries

In a disgusting display of propaganda, media outlet Reuters has released an article claiming that, default or not, Asian investors and central banks are “hostage” to U.S. debt:

http://www.reuters.com/article/2013/09/29/us-usa-debt-asia-analysis-idUSBRE98S0GY20130929

Their argument essentially revolves around the lie that Asian investors believe an American default to be “unthinkable”.  Surely, the unnamed Japanese investment source they cite as an “insider” truly represents the whole of Asia.   

The reality is, the Asians (the Chinese in particular) have been preparing for a calamity in the U.S. Treasury market for years.

Most foreign investors in U.S. Treasuries have converted their long term bond holdings to short term bond holdings; meaning, they are ready to liquidate their bonds at a moment's notice.  Overall purchase levels of treasuries are either static, or falling depending on the nation involved.

China has been internationalizing its currency, the Yuan, since 2005.  China has opened Yuan “clearing houses in multiple countries to allow faster convertibility of the Yuan, quietly supplanting the dollar as the world reserve currency.  These clearing houses now exist in London, Hong Kong, Singapore, Taiwan, and Kenya.  The Federal Reserve and international banks like JP Morgan are heavily involved in the internationalization of the Yuan.

The assertion that Asia is somehow hostage to U.S. debt is a lie beyond all proportions.  In truth, the U.S. economy is actually hostage to Asian holdings of U.S. debt.  A call for a dump of U.S. treasury bonds by China, for example, in the face of a U.S. default, would immediately result in a global chain reaction ending in the destruction of the dollar as the world reserve currency.  This is not speculation, this is mathematical fact.  China is not going to sit back and do nothing while their investment in U.S. debt quickly disintegrates.  Why would they take the chance when they could could just sell, sell, sell!

The very idea that Reuters is attempting to twist the fundamentals surrounding a default event leads me to believe a default event may be preordained. 

What Will Be Defunded?

Non-essential personnel (which apparently includes Obama's maids), will be the first to receive a pink slip from the federal government.  Extra Pentagon staff, EPA staff, FDA staff, IRS staff, etc will all be cut.  Good riddance.  But what will follow will not be so pleasant. 

If a shutdown stretches for months, expect cuts in all support programs and entitlements.  Veterans disability checks, social security, Medicare, employee pensions, even the Postal Service is likely to undergo defunding.  National Parks, and schools that receive federal aid will discover immediate cash-loss.  In fact, any state or city that relies on federal funds should plan for the possibility that those funds will disappear. 

Military cuts would be at the bottom of the list, but I would not discount the chance of that either.

It cannot be denied; an enormous subsection of the American public is dependent on federal money.  If that money dries up, chaos will ensue.  I don't like it, but it is a concern.

Controlled Reaction

A long term shutdown will be catastrophe no matter how you slice it.  Foreign creditors will react harshly.  The bond market will see a haircut not unlike that given to investors in Greek treasuries.  Austerity will become an American way of life.  The only mitigating factor will be the Federal Reserve, which I believe may institute “extraordinary measures” without congressional consent in order to continue feeding stimulus into government regardless of whether the debt ceiling is raised or not.  Given enough desperation, the American public might even applaud such an action and praise the Fed as “heroic”.

In this situation, the U.S. would be facing a Weimar-style currency collapse, rather than a debt default.  But in either scenario, the dollar is the final target.  

Unfortunately, too many economic analysts presume that the only threat to the dollar's value is hyperinflation (these are the same people that quote the Fed's crooked CPI numbers).  But the dollar is just as vulnerable to a debt default and loss of reserve status.  Devaluation seems to be inevitable regardless of the outcome of the funding debate. 

The Republicans could still surrender, and even if they don't, real damages will not be felt until after October 17th.  This is plenty of time to manipulate the public into demanding more spending even when more spending is not in our best interests in the long term.  Our greatest concern, though, should be whether or not the establishment is ready to pull the plug on the dollar altogether, using the debt ceiling crisis as cover in order to distract away from the involvement of international banks in the overall problem.  There is no doubt given the facts at hand that America is on the edge of a terrible pyre.  Is this the event that will finally trigger collapse?  We'll know more in a week...

EARNINGS - Q3 Earnings Warnings Second-Worst Since 2001

Q3 Earnings Warnings Second-Worst Since 2001 09-30-13 Zero Hedge

US companies are warning about Q3 earnings at the second highest level since 2001, with estimates well below what they were just three short months ago. Of course, the US equity markets don't care - having rallied aggressively in the face of this collapse; lubricated by multiple-expanding QE and rev. repo. As Reuters reports, companies issuing negative outlooks outnumber positive ones by 5.2-to-1, the most negative since the 6.3-to-1 ratio in the second quarter, when however the "second half recovery" (which has been once again indefinitely delayed, perhaps to the third half?) was said would take place momentarily and lead to another mythical rebound. Industrials, Materials, and Tech top the list for negative pre-announcements.

Via Reuters,

Third-quarter earnings for S&P 500 companies were expected to increase by 4.6% compared with a year ago, down from a forecast of 8.5% on July 1.

...

Technology is the sector with the highest number of third-quarter negative outlooks, with 27 warnings. Among them was Autodesk Inc, which anticipates lower demand for its computer-aided design software used in construction, manufacturing and engineering.

Consumer discretionary companies have the second highest number of warnings, including Target Corp. Target said in August that shoppers remained cautious and that its new Canadian stores were not doing as well as anticipated.

...

"there's a lot of noise right now that's driving sector performance, and not the fundamentals."

Of course, the complete disconnect between corporate profitability and forward earnings, has been well-documented, but just in case some have forgotten here it is again.

(h/t @Not_Jim_Cramer)

PRECIOUS METALS - Winners in Q3

Gold and Silver handily outperformed US equities on the quarter

Click to Expand

VALUATIONS - Largest 2 Year Multiple Expansion Since Late 90's

Charting The Bubble In Multiple Expansion 09-30-13 Barclays via ZH

The equity market has discounted a large portion of any improved outlook that the always-optimistic sell-side strategists believe is just around the corner. As Barclays notes, we have just witnessed the largest two-year expansion of P/E multiples since the late 90’s. This 'bubble' of optimism, sparked by a repressive Fed policy, combined with historical valuation metrics that are above their long-term averages, implies a correction and a period of consolidation is likely to plague the U.S. equity market during the first half of 2014.

Via Barclays,

The improved outlook is fully discounted in share prices... Given that historical valuation metrics are above their long-term averages it is difficult to make a case to the contrary.

...and the largest two-year expansion of PE multiples since the late 90’s implies a correction and a period of consolidation is likely to plague the U.S. equity market during the first half of 2014.