We are watching another US president with another debt ceiling to raise, but this time the chest-thumping is taking too long for markets to ignore. Meanwhile, Brexit has another deadline.
Risk in Risk-Free Assets
The US government shutdown has already lasted longer than the last 14 shutdowns since 1980. For the perplexed non-US audience, this is normal political posturing that the two American parties engage in every time there is a federal budget to be passed. Passing the budget comes with an agreement to increase the Federal Government’s debt ceiling limit. For credit risk exposure by US Treasury holders, this counts as the willingness to pay rather than the ability to pay.
To be clear, we do not see this as a major risk for the credit quality of the United States in terms of its ability to pay. The US borrows in its own currency, which can be monetized by the Fed ad infinitum. Treasury’s General Account at the Federal Reserve is well funded with $349 billion in cash holdings. So all the US government have to do is act to pay its liabilities.
Paying liabilities to its employees seems to be another matter. It is unfortunate that Trump has decided to skip payments of salaries to more than 800,000 Federal Government employees and blame the Democrats for it. This negotiating tactic to get funding for the wall on the Mexican border has a direct negative impact on GDP and more difficult-to-predict negative impact on sentiment.
Kicking the Can
The UK’s economic growth is slowing. Manufacturing registered a fifth month of declines, with the auto industry in panic. Both Ford and Jaguar Land Rover announced job cuts in the United Kingdom and in wider Europe. Japanese Prime Minister Abe joined the chorus on behalf of Japanese auto manufacturers and pleaded with the UK to avoid a no-deal Brexit.
On the 10th of December 2018, we pointed out that “there are too many factions opposed to the deal in its current form.” We also warned that Theresa May could delay the Parliament’s vote until she gets more concessions from Brussels. The wait is over, and Brussels did not budge on the original deal, which leaves many unresolved issues with respect to the Irish border. Parliament must now vote on the deal in its current form.
We do not believe the British Parliament will pass the Brexit deal. What remains is a defeat for May that will likely end in a general election and postponement of Article 50. Kicking the can further down the road seems to be the best option available for the UK. With Brexit fears already taking their toll on the British consumer, the UK is stuck in a suboptimal growth environment.
Autos in the Slow Lane
Automobile manufacturers have been going from one crisis to the next. The emissions scandals gave way to the accelerated rise of electric vehicles. Millennials without family obligations are less likely to own cars. Those that do, are opting for the SUVs and crossovers, which had Ford shutting down sedan production in the US.
Ford and Jaguar Land Rover announced layoffs throughout Europe. Brexit is making matters worse for the supply chains that cross borders between the UK, Germany, Spain and the rest of Europe. German automakers are facing demand destruction from Brexit and a slowing German economy, and we will likely see similar cost-cutting by this group in the months to come.
As ride-sharing and self-driving cars threaten to turn the ownership model upside down, we are reminded again why Ford’s bonds have been trading like junk even as they maintain their investment-grade ratings. We are watching Ford’s bonds closely for the next downgrade, which may present a buying opportunity. Moody’s last revision came in August to just one notch above the junk-rating.
The Week Ahead
US Trade Balance data comes out this week, and we expect nothing less than more ammunition for Trump during his trade talks with the Chinese. PPI figures will be out in the US and Japan and CPI figures are released by the European majors and Eurozone. China and South Korea report GDP. Turkey, South Africa, and Indonesia will announce decisions on monetary policy rates.
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