3 Month Debt Ceiling Increase

Trump-Pelosi-Schumer Deal

On Wednesday, the stock market rallied slightly lowering the possibility of the first 3% selloff of the year occurring this week. Those who described the selloff on Tuesday as devastating because it was the worst day since August 17th look silly because a normal day wiped half of it away as the S&P 500 was up 0.31%. One of the reasons the stock market rallied is because Trump met with House Minority Leader Nancy Pelosi and Senate Minority Leader Chuck Schumer to get a deal done on the debt ceiling. This was a twist in the issue as it was thought to play itself out over the next few weeks and it’s unusual for the two parties to agree on an issue so quickly.

Trump made the following statement on deal that was made. He said, “We agreed to a three-month extension on debt ceiling, which they consider to be sacred — very important — always we'll agree on debt ceiling automatically because of the importance of it. Also, on the CRs and also on Harvey, which now we're going to be adding something because of what's going on in Florida. We essentially came to a deal. So we have an extension that will go out until December 15th. That'll include debt ceiling, that'll include the CRs, and it will include Harvey. The amount of money to be determined, because everyone is in favor, obviously, of taking care of that situation.” As you can see, the Harvey relief, the continuing resolution for the budget, and the debt ceiling increase will all be packaged together. FEMA is expected to run out of money by Friday which would be a disaster because hurricane Irma will start to effect Florida on Saturday.

That was the good part of the deal. The bad part is that the deal is only for 3 months, so we will need to revisit this story in December as the new deadline will be December 15th. Mitch McConnell supports this deal, but Paul Ryan criticized it for being too short before Trump came to the agreement. The rank and file members of both parties still need to be convinced of the deal, but it looks like the risk has been successfully kicked down the road for the second time this year. There is now a 51% chance the debt ceiling will be raised from September 9th to September 15th. The PredictIt market will need to set another betting series soon after this passed. This could be a positive signal that the Dems and the GOP will work together on tax reform, but that’s much tougher. On the other hand, it might make the debt ceiling an issue that doesn’t go away, preventing discussion on other issues like healthcare reform, tax cuts, and infrastructure stimulus.

Looking at the game theory, many in the GOP are angry with this deal because the debt ceiling increase needs 60 votes. Every time it needs to be increased, the GOP needs to give the Dems something to incentivize them to support the increase. Instead of raising the ceiling for 18 months, this 3 month increase implies there will be another compromise in December, forcing the GOP to give in to more of the Dems’ demands.

Economic News

There were a few economic reports on Tuesday and Wednesday which we will go over. The most important report was the ISM non-manufacturing report for August which came on the heels of the great manufacturing ISM report. The non-manufacturing report came in just as expected as the headline number was 55.3%. That’s below the 12-month average which is 56.2%. It’s consistent with GDP growth of 2.5% which is probably close to what Q3 will look like barring any affects from the hurricanes. The chart below breaks down the report. As you can see, most of the metrics are accelerating and all of the non-manufacturing metrics are below the manufacturing metrics.

A finance and insurance company said, "Economy is chugging along. Decent crop yields seem to be offsetting poor commodity prices to some extent. Construction abounds." There is about to be a shortage in oranges because of hurricane Irma. The insurance industry is also about to be overturned. Travelers stock is down 9.54% from its closing high even after the 1.99% rally on Wednesday. Home Depot stock continued to rally with a 2.36% increase on Wednesday putting it about 2 points off its all-time closing high. I expect the weakness in Travelers and the strength in Home Depot to continue as the hurricane doesn’t look like it will hit Cuba which would slow it down. It’s also projected to cause damage throughout the southeast coast, not just Florida.

On Tuesday, Gallup’s economic confidence index was released. It came in at +6 which was 2 points higher than expected and 2 points higher than July. It’s still off the +11 peak in January, but signals the economy is still headed in the right direction as we approach the holiday spending season.

As you can see from the chart below, a familiar site is brewing as the GDP Now forecast is once again falling from its lofty initial expectations. Now the forecast is for 2.9% growth which is down from the previous estimate for 3.2% growth. The decline stemmed from the weak international trade and the weak lightweight vehicle sales reports. Now almost every estimate has a slight decline from Q2’s 3.0% growth baked in.

Conclusion

This chapter of the debt ceiling debate is now almost over. Unfortunately, the next chapter starts in a few weeks as this is a very temporary raise. The weak economic reports which are knocking down the GDP estimate are going to push the Fed to be more dovish in its next meeting in 2 weeks. The meeting will be a dovish unwind as the balance sheet shrinkage will start in October. Every meeting is of heightened importance as we now try to read the tea leaves on who will be the next Fed chair.

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