To The Moon

Since May, the market's biggest concern has shifted from CPI to the discussion of the US debt limit. The media is creating an atmosphere of fear if the US government defaults. If a black swan event occurs, it will be unavoidable for stocks, bonds and currencies to experience a "triple kill". However, it is common for both parties in Congress to reach consensus at the last minute because no one wants to become such a "heinous criminal".

As we have discussed before, with Republicans controlling the House of Representatives and Democrats controlling the Senate and White House, their main disagreement lies in raising the debt ceiling under certain conditions. Republicans believe that raising the debt ceiling must be accompanied by strict fiscal reduction commitments while Democrats hope to raise it as much as possible without reducing spending. Republicans believe that there has been excessive fiscal expansion since COVID-19 and future cuts should focus on non-defense discretionary spending while hoping to increase defense spending.

Finally, on Saturday May 27th Biden and McCarthy reached a preliminary agreement on raising the debt ceiling which includes:

-Raising the debt limit by about $4 trillion over two years consistent with previous budget agreements reached in 2015, 2018 and 2019;

-Rolling back non-defense discretionary spending levels to those seen in FY2022; capping total federal outlays below annual growth rates of 1% over six years;

-Eliminating statutory limits after FY2025 so only “unexecutable appropriation targets” remain;

-Matching defense appropriations roughly equaling $900 billion requested by President Biden in his FY2024 budget proposal;

-Fully funding veterans’ health care including through enactment of toxic exposure legislation via bipartisan PACT Act;

-Increasing minimum age for able-bodied food stamp recipients from age 49 to age 54 but also expanding who qualifies for welfare reform;

-Reclaiming unused funds from COVID-19 relief accounts

-Cutting IRS funding “without canceling all of the $80 billion approved last year”;

-Energy permit reforms sought by Republicans; and

-No new taxes.

With the debt ceiling raised, the US Treasury will continue to issue bonds which will have more impact on the market. In the short term, issuing new bonds from the US Treasury may affect market liquidity. The amount of funds in Federal Reserve's deposit account (TGA) is expected to continue rising and a portion of it may be occupied by subsequent issuances of government bonds, leading to tighter liquidity. At the same time, increased supply may depress US bond prices and there could be upward pressure on yields.

Meanwhile, resolving the debt ceiling issue will remove obstacles for Fed rate hikes. As economic data in May showed strong performance with PCE inflation higher than expected by markets once again proving inflation stickiness.

United States Core PCE Price Index Annual Change

Expectations for a 25 basis point hike in June implied by Friday's interest rate futures market rose sharply from less than 30% one week earlier to over 60%.

Reflecting an increase in expectations for further policy rate increases in America, yields on ten-year Treasuries have also continued to rise recently.

But why did US stocks hit record highs again? Tech leaders played a crucial role. The recent dominance of technology stocks led $NASDAQ(.IXIC)$ far ahead of other two major indices $DJIA(.DJI)$ and $S&P 500(.SPX)$ , with actual gains mainly driven by tech stocks.

Last week Nvidia's earnings report greatly exceeded expectations and significantly improved guidance for next quarter making markets even more optimistic about AI commercialization's impact on corporate performance.