U.S. Treasury default risks jump to 2-1/2 month high as debt ceiling showdown nears
ADP employment expected to show trend increase and support the U.S. economic outlook
Weekly EIA report expected to show a continued sharp drop in U.S. crude oil inventories
U.S. Treasury default risks jump to 2-1/2 month high as debt ceiling showdown nears — The 5-year U.S. credit default swap (CDS) price has jumped by about 5 bp since the middle of last week to Tuesday’s 2-1/2 month high of 24.9 bp. The 5-year CDS price represents the cost of insuring against a U.S. sovereign debt default within the next 5 years. The 5-year CDS price is still relatively tame compared with the peak of 30 bp seen in December after President Trump’s victory in the November election and the 8-year high of about 60 bp seen during the 2011 debt ceiling crisis.
The failure of Senate Republicans last Thursday night to approve any kind of Obamacare repeal bill apparently sparked market worries that Republicans may see similar fissures in trying to raise the debt ceiling. The conservative House Freedom Caucus in any case is unlikely to support a debt ceiling hike, meaning Democratic votes are likely to be necessary in the end to approve a debt ceiling hike.
No progress was made on the debt ceiling at a meeting on Tuesday morning among Treasury Secretary Mnuchin, Senate Majority Leader McConnell, and Senate Minority Leader Schumer, according to reporting by the Washington Post. Treasury Secretary Mnuchin is pushing Congress to approve a clean debt ceiling hike by Sep 29, before the CBO’s estimated X-date of early to mid-October. There will only be few weeks during September left to raise the debt ceiling after Congress returns from its August recess.
On the X-date in early to mid-October, the Treasury will be in the same position as that of a bankrupt company that cannot borrow money and does not have enough cash left to pay all of its bills. It remains uncertain whether the Treasury could, or would, prioritize its bills to use what cash it has to pay interest and principal on Treasury securities and avoid a sovereign debt default, while deferring such payments as salaries to government and military employees and Social Security payments. Mr. Mnuchin recently said that prioritizing payments doesn’t make sense and he implored Congress to avoid the problem altogether by raising the debt ceiling.
However, White House Budget Director Mick Mulvaney has been outspoken in saying that he thinks the Treasury could go past the X-date by prioritizing its debt payments, making the markets nervous that a Congressional game of chicken might go too far. Adding to the potential for chaos around Oct 1, Congress must pass spending authority for the new fiscal year or there will be a government shut-down on Oct 1.
ADP employment expected to show trend increase and support the U.S. economic outlook — The market consensus is for today’s July ADP employment report to show an increase of +190,000, which would be very close to the 12-month trend average of +193,000. The ADP data has been volatile in the past three months, ranging from a low of +148,000 in April to a high of +230,000 in May.
On the labor front, the market is mainly looking ahead to Friday’s July payroll report, which is expected to show an increase of +180,000, close to the 12-month trend increase of +187,000 but down from June’s +222,000. Payroll growth was shaky at +50,000 in March and +152,000 in May, but otherwise payrolls have been strong at more than +200,000 in the other months of this year.
Meanwhile, the consensus is for Friday’s July unemployment rate to fall by -0.1 point to 4.3%, thereby matching May’s 16-year low of 4.3%. That would leave the unemployment rate virtually right at the Fed’s forecast for a unemployment rate of +4.3% by late this year and 4.2% in 2018-19. Those forecasts indicate that the Fed expects the U.S. unemployment rate to run below the Fed’s estimate of a longer-run natural unemployment rate of 4.6%, which means a tight labor market where wages should be seeing upward pressure. However, those wage gains have yet to emerge. The June U.S. average hourly earnings report of +2.5% y/y in fact was down from December’s 8-year high of +2.9%.
Weekly EIA report expected to show a continued sharp drop in U.S. crude oil inventories — The market consensus for today’s weekly EIA report is for a -3.0 million bbl decline in U.S. crude oil inventories, a -1.0 million bbl decline in gasoline inventories, a -750,000 bbl decline in distillate inventories, and a -0.5 point decline in the refinery utilization rate to 93.8%.
Oil prices have risen sharply over the past month partly because of the -25.8 million bbl (-5.1%) drop in U.S. crude oil inventories seen in the past four reporting weeks. U.S. crude oil inventories are still in a glut at +24.0% above the 5-year seasonal average, but inventories are actually below last year’s level at this time and have fallen to the tightest level in two years relative to the 5-year average. Meanwhile, product inventories remain ample with gasoline inventories at +3.9% above the seasonal 5-year average and distillate inventories at +11.3% above the 5-year average.
On the production front, the markets will be carefully watching to see if U.S. crude oil production is starting to plateau due to the mostly sub-$50 oil prices seen since May. U.S. oil production last week fell slightly by -0.2% from the previous week’s 2-year high and the number of U.S. oil rigs has been little changed in the past three weeks. Schlumberger’s management last week said that it sees U.S. oil producers “tapping the brakes” on opening new wells due to the recent weakness in oil prices.