Only losers in the debt dispute in the USA, interest rates could rise further.

Chart of the week

The chart shows two measures of inflation in the USA, one adjusted and one unadjusted. The official inflation rate (CPI, Consumer Price Index) is shown in blue. Since energy and food prices often fluctuate strongly, the official inflation (dark blue) and the core CPI (light blue) are shown in addition.
Private consumption expenditure is shown in yellow. The inflation rate is calculated with a basket of goods and services. In times of inflation, consumers will stop buying certain things and postpone investments. Consumer spending thus indicates the additional costs that effectively burden households.

Why it matters
Last week, the increase in consumer spending for the month of April in the USA was published. It was expected to be the same as the previous month at 4.6. However, the number that was published was 4.7%, slightly higher. So inflation or consumer spending continues to increase.

Currently, the PCI is more important than the CPI. So far, the Fed has mostly argued with an increase in the PCI for all interest rate hikes. This is therefore the preferred measure of the decision-makers.

The chart shows the probability with which market participants expect a rate hike to 5.25-5.5% on June 14. June 14 is the next meeting of the US Federal Reserve.

Just a week ago, 82% expected interest rates to remain unchanged. Last week's PCI publication changed everything. Now 64% expect another interest rate hike of 0.25%. This is likely to further fuel the banking crisis and hit growth stocks, which are heavily dependent on credit.

Only losers in the debt dispute in the USA

The good information first. On Saturday, it was announced that President Biden and Kevin McCarthy the Speaker of the U.S. House of Representatives have reached a deal. On Wednesday, both chambers of the House will vote on the deal.

President Biden must now convince his Democrats, and predominantly the far left wing, of the deal. Kevin McCarthy faces a much tougher task; he must convince the right wing of the Republicans, the Freedom Caucus. The group includes 35-45 lawmakers, all of whom are under the strong influence of Donald Trump.

So an agreement is not yet certain.
But what is it all about?

The graph shows the steady increase in the US national debt. Parliament sets the maximum possible national debt. This limit is currently USD 31 trillion.

In 1970, the debt was 35% of the US gross national product, now it is 129%. As recently as last year, the US had to spend about 5% of gross national product on debt interest. Now, because of generally higher interest rates, this may rise to as much as 10%.

These two comparisons help to better understand the numbers:

- The whole national debt in 1 USD bills would have a height of approx, 11k. That is about the height at which airliners fly.

- The USA is currently in the same position as a private person who has USD 1000 in the account, but debts USD 524'000.

Last Thursday, the U.S. Treasury Secretary Janet Yellen, sent a letter to the Speaker of the U.S. House of Representatives, Kevin McCarthy with the following content:
"We will make more than $130 billion in scheduled payments in the first two days of June, including payments to veterans and Social Security and Medicare beneficiaries. These payments will leave Treasury with an extremely low level of resources. As of the week of June 5, Treasury plans to make estimated payments and transfers of $92 billion, including a regularly scheduled quarterly adjustment that would result in an investment in the Social Security and Medicare trust funds of about $36 billion. Therefore, our projected resources would be insufficient to meet all of these obligations."
In other words, as of June 5, the U.S. government's resources are insufficient to make all the payments. Only revenue from taxes could be used at that time, he said.

Starting June 5, the U.S. government will have to prioritize who gets what. In 2011, there was already such a case. At that time, the first thing to be closed were the non-central government facilities and the civil servants were sent on forced vacation. These were, for example, all rangers (closure of nature parks) or planning authorities (no more building permits).

In any case, the U.S. government is then expected to stop paying interest on its debt.

The U.S. government has published a study showing how negatively a default in the U.S. would affect the economy. "Brinkmanship" refers to the current situation, a last-second solution that is still possible. A default of less than three months (short duration) would have little impact. If the default were to last longer (protracted default), the impact would be massive. Gross national product (GNP) could fall by over 6%.
Of course, these figures should be taken with a grain of salt. The government, led by the Democrats, is currently interested in dramatizing the situation in order to force the Republicans to compromise.
If the U.S. fails to meet its bond obligations, this will lead to national bankruptcy, which has not been the case since the founding of the United States in 1776. Because of the central role U.S. government bonds play in the global financial system, the consequences could be catastrophic. For example, many central banks hold a large portion of their foreign exchange reserves in the form of U.S. government bonds. Many commercial banks and insurance companies around the world also hold U.S. government bonds. U.S. government bonds are considered one of the safest investments in the world because they are based on the credibility of the U.S. government and a U.S. default was previously considered unthinkable.

There are only losers in such a scenario:

- Sovereign:
Various rating agencies have already assigned the U.S. a "watch" outlook. A downgrade of debtor quality is possible. This could result in significant additional debt interest costs for years to come.

- Politics:
The reputation of politicians would decline massively. Ordinary citizens do not understand the dispute, especially all recipients of direct support such as pensioners and veterans.

- Citizens:
Massive cuts in government spending loom. Pensions, social spending, Medicare spending could plummet (this is the main Republican proposal).

- Companies:
Government contracts would be canceled. The energy transition could be massively delayed. This will cause many companies to lose revenue.

A lesson from 2011 is also interesting. Voters do not blame the incumbent president for the situation (he wants to pay), but the party that prevents the payouts (i.e., the Republicans). So the "Freedom Cusacus" has to think carefully about how much he wants to escalate the situation so as not to torpedo a possible victory as president for Trump or De Santis next year.

The chart shows how the individual asset classes behaved in 2011, when we had a similar situation.  

Gold is the clear winner. It is to be expected that bitcoin would also gain in such a scenario.
Many American investors and pension funds are forced to invest in U.S. government bonds. They are selling the short-term bonds and buying the longest-term bond available, the 30-year Treasury bond. That's why these long-term bonds are also increasing in value.
Hopefully, we will be spared such a scenario. Wednesday's vote in both chambers of the U.S. Parliament will be one of the most important votes this year.