Overview

US debt ceiling concerns and weakness from China continue to weigh on markets. With little more than rumours from DC to calm the markets, expect increasing stress to manifest as time passes until something concrete arrives. The problem with the game of chicken is not that either party wants disaster, it is that in trying to threaten the other with disaster, the point-of-no-return may be misjudged. Market participants are certainly taking such risks increasingly seriously. Inflation readings coming in ever so slightly below expectation was the silver lining last week, but the consolation feels scant. Crypto mainlines show weakness as altcoins and memecoins show strength, traditionally a sign that the current rally is coming to an end.

Debt Ceiling

With Yellen’s predicted x-date fast approaching, Biden set to fly to G7 and Washington failing to deliver a resolution, the possibility of a default is looking more real with each passing day. Should Biden be forced to cancel his trip, there would be a blow to the US’ global standings and no one would walk away looking pretty. Let this be clear: the standoff is between the Republican-controlled Capitol and the Democrat-controlled White House. Should Biden leave for G7, progress will be difficult if not impossible.

Even if everything works out in the end, trust in the US government will be eroded. In the past, this visibility manifested in a downgrade from AAA to AA+ by S&P in 2011. In 2023, we are looking at a situation where the US fiscal position is substantially worse, interest payments are substantially higher, and politics are more polarized than ever. The problem will zoom out from the immediate issue of whether the US government’s bills can be paid in the coming month to whether the US government with its captured and divided institutions can fulfill its most basic and mechanistic functions, let alone deliver meaningful policy to guide it into the future. It is quite likely that we will see another downgrade by a major rating agency after everything passes. If CDS spreads are anything to go by, the US government as it stands is already far from AAA rated in the eyes of investors.

Credit Crunch

The US banking sector continues to be under stress. In the short term, we have not seen contagion in the form of one bank failing resulting in the balance sheets of another collapsing. We are instead seeing broader systemic pressures that continue to threaten regional banks in particular. There is irony with JP Morgan taking over First Republic when First Republic’s collapse is in no small part driven by deposit flight from regionals to larger banks. If PacWest is any indication, the FDIC’s willingness to guarantee Silicon Valley Bank’s depositors beyond the original $250,000 limit has not fully arrested withdrawals. The question then becomes, what other tools are available to policy makers to stabilize the system, if the essentially unlimited liquidity promised seems to not have done the trick?

The result thus far has been a steep drop in US bank credit growth, which historically has been a strong predictor for incoming recessionary pressures. The effects are beginning at last to be more sharply felt in the real economy, producing a wave of bankruptcies. This is in line with the inverted yield curve in US treasuries that has been on clear display. In a world of mixed signals, the strong historical fundamentals continue to suggest a recession is coming while arguments for a bull market remain largely a rehashing of “it hasn’t happened yet”.

Crypto

The rotation from mainline cryptos into altcoins and memecoins continues. In the past, this is a sign that crypto’s broad-based rally is weakening as crypto longs are looking for improved returns elsewhere with their winnings, with the expectation that mainlines will not continue to make gains in the short term. Both BTC and ETH have slipped substantially from mid-April peaks, with more weakness likely. Lower liquidity in broader financial markets does not help either.

While these mainline alternatives do have the potential to moon, the risk is substantial and frictional losses from poor liquidity, price discovery and high transaction fees are likely to cost the average investor substantially. An alternative way to look at the situation is to consider if the coin being looked at will likely continue to perform well if BTC and ETH take a steep plunge. In most cases, the answer is no, in which case the case for moving from mainlines is much weaker.

Upcoming Calendar Events

• Empire State manufacturing survey (15 May)
• US Retail data (17 May)
• US initial jobless claims (18 May) 
• US leading economic indicators (18 May)

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