How many ways can a monetary policy expert or official say “it’s ain’t over ‘til it’s over”?

Outlook: How many ways can a monetary policy expert or official say “it’s ain’t over ‘til it’s over”? At Davos, where the World Economic Forum ends today, Swiss National Bank chief Jordan warned against second-round effects. “Firms do not hesitate anymore to raise prices and that is a signal that it will not be easy to bring inflation back to 2 percent.” Ex TreaSec Summers admitted the market is likely wrong about a lower terminal rate that comes sooner. His real contribution is a pushback against former IMF chief Blanchard, who said maybe it’s okay for central banks to lift the 2% target. That would damage credibility.

As Reuters puts it (again), “Federal Reserve officials have been resolute all week in insisting policy rates will go above 5% this year from the current 4.25-4.50% range and won't come down until 2024. Markets still doubt them and futures markets only nudged their implied 'terminal rate' up to 4.9% overnight while still pricing almost half a percentage point of cuts in the second half of the year.”

To the Swiss argument we would add that energy prices are abnormally soft for various reasons, including the secret rise in Iranian exports. If oil (and natgas) start rising again to near $100 or over it, as seems all too likely given the pick-up in growth, all these forecasts of inflation having peaked come into question. It’s a mystery why oil prices gets neglected as the central driver of inflation, especially when we have governments in the UK and Europe subsidizing households.

In addition and far worse, we are starting to think the talk of central banks vs. markets is about to get tossed out on its ear. That’s because the debt ceiling problem in the US is going to turn into a genuine crisis because the radical Republicans are choosing to do it. As Reuters reports, we have the first inklings: “With many investors likely to avoid short-term debt instruments and related cash-management vehicles until the issue is resolved, the starkest reflection of the concern this week has been the biggest inversion in the 3-month-to-10-year yield curve in 40 years.”

It hasn’t sunk in yet, but the US hit the debt ceiling yesterday at $31.4 trillion, meaning the Treasury had to start fiddling with various spending items, starting with federal employee pension funds. As TreasSec Yellen wrote to Congress last week, "Failure to meet the government’s obligations would cause irreparable harm to the U.S. economy, the livelihoods of all Americans and global financial stability. I respectfully urge Congress to act promptly to protect the full faith and credit of the United States."

It’s obvious to everybody except the radical right in the House that reducing the deficit is not the same as reducing the debt. And the right would prefer to forget that about 25% of that debt was added by Trump alone (although to be fair, in dollar terms Obama added more). The Republican penchant for giant Pentagon spending and tax cuts runs directly counter to its traditional claim to want rational debt management. Again to be fair, most of the “mandatory” spending was passed by Dems (Social Security, Medicare, etc.). All the same, as comedians point out, the debt was already incurred and to refuse payment is like refusing to pay a mortgage. You will end up in the street. That’s how it works.

As noted before, one not-so-silly remedy is to issue debt with gigantic yields attached, since principal is “debt” but interest payments are not. There is also that trillion-dollar platinum coin, but that doesn’t help when June arrives and the money box has no actual cash. Sell the trillion dollar coin to the Saudis?

Politically, the administration says it won’t wrestle with the House, which the radical right thinks means Biden won’t cut future spending when it’s really talking about not being able to cut past spending, literally. And the Biden gang wants no conditions until this crisis is settled, meaning education for people whose closed minds make it improbable. The right solution is to abolish the debt limit altogether! It was instituted after WW II to try to limit spending, but Congress couldn’t keep that promise–and has been modified over 100 times since then.

Yesterday the WSJ reported the Treasury has already started extraordinary measures to push off default. “Those accounting maneuvers, which include suspending investments for certain government accounts, will allow the Treasury to keep paying obligations to bondholders, Social Security recipients and others until at least early June.” But Yellen herself there is “considerable uncertainty” about how long extraordinary measures can last.

Some call it a game of chicken. It’s not. It’s a fast-moving object hitting a brick wall. The fast-moving object may get shattered, but the wall will fall. We would not be surprised to see the gigantic-yield ploy activated but before then, another sovereign debt downgrade from the ratings agencies. If they do not downgrade and PDQ, they are not doing their jobs. This will have the effect of raising yields as sellers come out of the woodwork, as we deserve. You’d think equities would benefit, but don’t underestimate the power of fear.

We get this negativity from interviews with Democratic Congressmen on TV saying they perceive the radical right as wanting to default and looking forward to wielding the biggest weapon. They fail to appreciate the magnitude of what they seek. Choosing to fight the Treasury Department is not smart, but then, these radicals are not smart in the first place (they still buy into the idea that Trump was defrauded in the 2020 election).

If the Congressmen are correct and the radicals plan to take the battle to a bitter end, perhaps past ratings downgrade to an inch from actual default, the market will not like it. This is the only time we are willing to admit the dollar’s reserve currency status could be set on a downward path. As for the immediate effects in FX, risk-off generally favors the dollar as the safe-haven but safe-haven status depends on the “full faith and credit.” So presumably not, although we saw that perverse effect when Trump was doing high-risk stuff.

This is going to be an ordeal. The Treasury can jigger its accounting until June when the true crisis would come. Most analysts imagine that a deal will get made before then, as has happened every other time, but many are starting to smell this is not like last time. If the Justice Dept charges Trump for stolen documents and/or sedition before then and a trial gets scheduled, as seems likely, it’s also likely the radicals get pepper up their noses and stiffen the resolve to “bring down the government.”

As in the case of the fraudster who got elected to Congress, so far there is nothing that can be done to expel him–it will take legal action, and even then, he can “serve” from jail. Maybe the Justice Dept can charge the radicals with the crime of violating their oath to the Constitution, but at the turtle pace of the Justice Dept, it would be 2024 before we saw the paperwork.

This is a big deal. It will wax and wane for the next 4 months but we must not neglect it as a genuine FX factor, and something more important than whether the market believes the Fed on that 5% until 2024. Which currency benefits from the US losing status? Weirdly, we guess it’s sterling, despite a long history of massive mismanagement, including Brexit. The UK was the traditional issuer of the reserve currency until it went hideously into debt due to WW II and the US grabbed the wheel in New Hampshire at Bretton Woods in 1944. While it’s still in debt, check out the table and see who else would be a decent candidate? Remember, you need volume and liquidity.

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