Last week neither bonds nor stocks moved much collectively.
We had some back and forth, some of which could be tied to debt ceiling headlines, but the debt ceiling talks, so far, remains mainly a sideshow. A lot of time and energy has been spent on the subject, but the market is not taking it seriously.
When I look at one year credit default swap (CDS) markets for U.S. government debt, I see about a 4.3% chance of having a "failure to pay" event occur on U.S. government debt. That seems reasonable to me given the noise I'm hearing from D.C.
In any case, the debt ceiling getting "resolved' will not be cause for a big rally, because with a few noticeable exceptions (U.S. CDS, short-dated T-bills, some option activity) very little fear of the debt ceiling is being priced in. I continue to view that as a bear, I'm getting a debt ceiling event for free.
Having said that, I expect if we get a default and/or ratings downgrades, Treasuries will rally! This isn't a "normal" default where people are concerned about the ability and willingness to pay over time. This will be viewed as largely "technical" but any longer-term ramifications will be to slow the economy, probably, and in some way ironically, Treasuries to rally if we see a default or get a downgrade.
Equities will be hit more, but even then, I expect this to be something that erodes confidence over time rather than creating immediate chaos. If they default (a big if), real world problems probably won't bubble to top of mind for a week or so, by which time, they ideally would have come to solution.
If they don't, then it could get nasty.
Not my base case, but worth being prepared for.
CONsumer CONfidence Was the Anti-Goldilocks
Rarely do I say this, but the consumer confidence number, which I generally ignore, warrants attention.
Friday's numbers were quite interesting as sentiment plummeted (57.7 was a drop from 63 and pulls us back to levels from last autumn). Current conditions and expectations also fell, continuing a trend. Given the historical correlations with the equity market, that move was a bit surprising.
On the other side of the coin, one-year inflation expectations remain at 4.5% (well above where the Fed would like to see them) and the longer-dated inflation expectations increased to 3.2%. The last time expectations for 5-10 year inflation was that high was back in May 2008!
This data is quite literally the anti-goldilocks. Rising inflation with weak growth has a name: stagflation.
Again, consumer confidence isn't something I rely on, but this one caught my eye, because it spun a negative story -- and I remain bearish, so who doesn't love some confirmation bias. However, because it wasn't accompanied by lower stock prices and higher energy prices, it likely means something, which is the "usual" correlation between consumer confidence and markets (hat tip to Bob Janjuah who I used to work with for putting the "CON" in consumer confidence).
SLOOS
Last week the market was focused on the Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) report, which I can readily admit, is one of the few times I can remember anyone even mentioning SLOOS, let alone focusing on it as a potential market moving event.
The most important part of that report, from my perspective, was the decline in loan demand.
Sure, the willingness to lend might be shrinking, but there are alternatives to borrowing from banks. The drop in demand for lending seems more problematic as it reflects companies (and individuals) seeing either a smaller opportunity sets or increasing concern about their ability to pay off such debt.
Bottom Line
I'm still bearish on credit and equities on a -4 out of a scale of -10 to 10. I'm largely neutral on rates, though there is potentially increased risk of a short squeeze.
