As if the widening Federal Budget deficits forecast by the Congressional Budget Office (CBO) weren’t bad enough, the Monthly Treasury Statement for August released last week, revealed that things are even worse than even the CBO thought.
But are we surprised?
We have been tracking this disaster month after month, as we watch the US Treasury dump an ever growing supply of new paper on the market month after month.
Now even the mainstream media is picking up the scent.
Gross Domestic Product (GDP) growth has fluctuated around a rate of 2.5% since 2010. The red line showing the GDP indexed to 2010 at 100, shows that those fluctuations have hardly been material in the big picture. If you believe the government statistics, the growth trend has been steady as she goes.
The blue line shows the 3 month moving average of withholding taxes also indexed to the 2010 average. They’re highly seasonal, but they were moving along the same trendline as GDP until this year. Then the tax cuts came and BOOM! Withholding taxes fell out of the trend.
As you can see on the lower graph, GDP had a spurt in the second quarter, if you believe the Bureau of Economic Analysis (BEA). Again, we expected this. There’s no mystery that deficits stimulate the economy. When the government borrows money to buy more stuff, that causes an increase in business sales.
Meanwhile, the growth rate of withholding taxes has turned to the shrinkage rate, falling to around minus 3% in July, before rebounding to near minus 2% in August. That’s hardly a sign of the tax cut “generating more revenue.” Withholding taxes always fluctuate. A couple of months of declines are always followed by a few months of upticks. Let’s see where this one fades out before we start talking about a gain in revenues.
Furthermore, the uptick in GDP growth isn’t even as high as a couple of quarters in 2014. So there’s not even that much evidence that the tax cut is stimulating much. For sure the economy would have been slower without it, but the limited economic gains produced by this spending have a cost.
I hate to beat the horse that’s already dead, but that cost is massive federal borrowing. The deficits must be paid for by the issuance of ever increasing amounts of Treasury debt. When that debt comes to market dealers and investors must buy it. The Fed stopped printing the money to buy all that paper at the end of 2014. And since October of 2017, the Fed has actually been extinguishing money. There’s less and less money in the banks, making it that much tougher for dealers and investors to absorb all the new paper.
Because of that, Treasury bill and note yields have been blowing the roof off. Short term bill rates and 2 year note yields are skyrocketing. The yield on the 10 year note is knocking at the door of 3% again.
The Stock Market Party Continues. But Don’t Be the Last One to Leave
Despite the mounting concerning evidence, the stock market parties on.
But it can’t last. As T-bill rates soar, and note and bond yields inevitably resume their rises, more and more investors will begin to make the safe choice. They’ll sell a few stocks and put their money into Treasuries.
Meanwhile strengthening economic data will strengthen the Fed’s resolve to keep tightening the monetary noose. The time is coming soon where there will no longer be enough liquidity to support higher stock prices in the face of the continuing onslaught of treasury supply.
If you have followed my advice in the past, you are largely out of stocks, and you can sleep at night, not having to worry about what might lie ahead. Now, we just need to be on the lookout for any sign of a technical break of stock market support. That will be the sign to begin adding a few more puts on the SPY to our tactical trading so that we can profit from the coming decline.
I will keep you updated right here at Sure Money for on any sign that that break has begun.