Interest rate development in the USA, stagflation in the USA looms, US government debt - A storm is brewing

Chart of the week

The chart shows the monthly average return in the broad U.S. stock market index since 1950 (yellow), over the past 20 years, blue), over the past 10 years (green) and in a pre-election year in the U.S. (black).
Why it matters
One of the most well-known stock market rules is "Sell in May and go away, and don't forget to come back in September or October." Historical observations show that an investor achieves a much better long-term return if he is only ever invested from October to May in the following year and keeps everything in cash from May to September. Over the past 10 years, this relationship has weakened, but May and June are historically bad stock market months.

Interest rate trends in the U.S.,
It's that time again this week. The U.S. Federal Reserve meets to decide on the next interest rate move.

The chart shows that 83.9% now expect a key interest rate of 5-5.25%. That is a further 0.25% increase in the key interest rate.
It is interesting to look into the future.

The chart shows a list of the next 12 meetings of the Federal Reserve and which key interest rate investors expect. In the first row, the May 3 meeting, the probability of 83.9% from the previous chart is circled in red.

Until November 11, investors expect stable interest rates, from then on it goes down again. On November 11, investors expect the next interest rate cut.
Currently, bonds are offering higher interest rates again, but if you don't hold them until maturity, you risk losing capital in the meantime. This is likely to change again as of November.

The chart is a good summary of how the U.S. economy is currently doing. The chart above shows gross national product (GDP) growth. This has been falling for three quarters.

The chart below shows consumer spending. This increased in the first quarter of 2023 to the surprise of many. Because of the massive increase in mortgage interest rates, most market observers had expected declining figures. In addition, there have been larger waves of layoffs, which typically make consumers more cautious. Everyone is talking about an impending recession and consumers are spending more; that's unusual. From the central bank's perspective, rising consumer spending is a problem when inflation is rising. That's because they fuel inflation further.

The chart shows the quarterly change in inflation in the USA. This is clearly down from the highs, but now seems to be settling into the system. Both headline inflation (brown bars) and less volatile inflation excluding energy and food prices have picked up somewhat in the first quarter of 2023.

These numbers are forcing the Federal Reserve to raise interest rates further to curb consumption and inflation.
We are currently seeing declining growth with inflation remaining high. In technical jargon, this is known as stagflation. This is a situation that no one wants to see in the long term.

The central banks are also trying to combat stagflation by reducing the money supply.

The chart shows the development of the central bank money supply since 1831. The phases in which it was negative are all annotated. So far, a falling money supply has always triggered a weakening of the economy. This is currently desired by the central bank, but the great danger is that the central banks overshoot and slow down too much.

We have already talked in detail about the market breadth in the last market reports. This chart shows it again in an impressive way. In the chart, the return of the broad market index S&P 500 is divided into two components. In red is the return of the 8 big companies Facebook, Apple, Amazon, Netflix, Google, Microsoft, Nvidia and Tesla. In blue, the return of all other 492 stocks in the benchmark.

It is clear to see that all the return in the main index came from only 8 stocks. Anyone who had not invested in these 8 stocks made no return.

Last week, Google and Microsoft delivered dream results once again. Growth was well above expectations and Google announced a record share buyback program. However, the very low market breadth suggests that we will see less good times in the stock market.

US government debt - A storm is brewing
The statutory debt ceiling of around $31.381 trillion was already reached on January 19. However, the "special measures" allow the U.S. Treasury to finance the national budget for several months without raising the debt ceiling.

The chart shows the steadily rising U.S. national debt (dark blue) and the statutory ceilings (light blue).

Recent lower-than-expected U.S. tax revenues have heightened fears of a sovereign default. As a result, the US Treasury could run out of money in June instead of July.
In the U.S., raising the debt ceiling has repeatedly become a political issue. Fiscally conservative Republican politicians regularly oppose raising the debt ceiling because they blame it on escalating national debt. Once again, what should be a technically necessary debt ceiling increase is a bone of contention between President Joe Biden's governing Democrats and Republicans.
The U.S. is on the verge of national bankruptcy this summer if the debt ceiling is not raised. Because U.S. government spending almost always exceeds revenues, the U.S. government is constantly relying on new debt assumptions.
The fight over the House speaker nomination in January showed how little Republicans care about conventions and how far they are willing to go. Kevin McCarthy was not elected Speaker of the U.S. House of Representatives until the 15th ballot.

This suggests that the Republicans, who are currently already campaigning, will go all out to inflict a historic disgrace on President Biden by bankrupting the US.  
Some investors expect the showdown in June and July. The two and three-month government bonds are therefore sold massively and shifted into government bonds with the maturity of one month.

The chart shows the yield of U.S. government bonds with a maturity of one month (red) and two months (green). Massive shifts have been taking place for about two weeks.

On the stock exchange, it is possible to insure against the default of a debtor. An insurance premium is paid, and this is paid if the debtor underlying the bond goes bankrupt. These insurance rights are traded on the stock exchange. They are called CDS (Credit Default Swaps).

The chart shows the price of CDS on U.S. government bonds. In the last week, prices have skyrocketed and are now higher than they were during the 2008 financial crisis or the last major standoff over the debt ceiling in 2013.
In the current case, the probability of such a scenario is still low, at about 10%. But with every week that no solution is found, the probability increases massively.
If it really comes to pass, the following market movements can be expected:

- Investors in short-term U.S. government bonds could suffer a total loss. CDS might not be a salvation either. In 2013, it was discussed that the insurance would only pay in case of a real bankruptcy and not a technical bankruptcy as in the case.

- The USD is likely to collapse. Investors would probably flee to the euro.

- The big winner is likely to be Bitcoin; a currency independent of politics and central banks.