Debt Ceiling + less fiscal deficit + increased inflation + crisis in China = A roaring bear¡

On Thursday afternoon, the President of the United States, Joe Biden approved a law so that the Federal Government can continue to function for 2 more months, thus avoiding the partial closure of the Government that I mentioned could happen. However, everything seems to indicate that the "fight" would be won by the Republicans since they are talking about an infrastructure package closer to USD1 trillion (versus Biden's original plan of USD2 trillion), as I wrote in the article of "Letter from Mr. Market" of July 24th. However, the interest of the Democrats is no longer apparently to defend Biden's original plan but to spend at all costs with the proposal a few months ago of the "Education, Anti-Poverty and Climate Change" plan for USD3.5 trillion. Republicans have signaled for weeks that they will not approve that level of spending and neither will the more conservative section of Democrats. Regardless of when and the final amount, the most likely scenario is that US fiscal spending is much lower than Mr. Market has in his estimates (the expectations of many analysts and investment banks were / are more optimistic), which it is already having an impact on consumption, investment and expectations.

With a lower fiscal deficit, the government's need for issuance will be less and that explains a large part of the fact that the beginning of the tapering is in the FOMC in early November (rather than the achievement of its surpassed inflation goals or those of employment), as Powell implied a few days ago.

Regarding the debt ceiling, Yellen pointed out this week that the "x" date for the US Treasury to run out of funds would be October 18 (1 to 2 weeks after the estimate that I indicated in this medium).

The Democrats theoretically have the votes to approve suspending the "debt ceiling" without the votes of the opposition party, in a legislative process called "reconciliation" in which they only need a majority of 1 vote out of 50 in the Senate. However, if it is used, the estimates say that they would not reach the "x date" indicated by Yellen, so the risk of default of the Government of the "risk-free" rates, although still low, grows with the passing of the days (the deadline for the market is Friday of next week).

For now, as the October 18th date given by Yellen approaches, the risk perceived by the market of a debt default will increase and also the risk of a drop in the risk classification of any of the main agencies as Fitch Ratings warned on Friday, October 1st. Republican leader Mitch McConnell today sent a harsh letter to Biden reminding him that the current position of the Republicans was known and was warned months ago by them, and that they will not compromise not to increase the debt ceiling as long as they follow very high proposals. spending, which are having an impact on inflation. Biden for his part today did not calm down much and mentioned in the morning: "In the days ahead, even before the default date, people may see the value of their retirement accounts shrink. They may see interest rates go up, which will ultimately raise their mortgage payments and car payments". Such a comment in a context where markets are already nervous can have unintended consequences such as mutual fund and deposits withdrawals (which does not calm, but rather exacerbates the crisis).

Regarding inflation, at least in the short term, the indicators that I manage would be showing inflation that would remain high in the coming months (where, for example, the worst drought in Brazil in 1 century does not help; however, this expectation of high inflation could change radically and quickly with a financial crisis or sudden recession), but the growth figures I have show that the 3Q and 4Q numbers would be lower than what the market expects. Therefore, we are getting closer and closer to a stage in the largest economy on the planet of stagflation, that is, low growth and high price increases, as the renowned economist Nouriel Roubini has pointed out for some months.

FEPIC leading indicator of US economic growth vs GDP growth

FEPIC's leading indicator of inflation (green) in the US in 12 months vs actual inflation (blue)

Regarding China, 3 things are happening. The first (which seems to me the most delicate), is that the electricity shortage observed in recent weeks is causing power "outages" in various regions of that country, which in some cases last for days. The same with the close of several manufacturing companies that have had to stop their production totally or partially due to the lack of energy. This could have an effect on the growth of the second largest economy on the planet and would also increase the lack of supply of some components and exacerbate the use of polluting fuels (such as coal and oil), for the production of electrical energy. This effect raises expectations of more inflation (in the short term), and less expected growth (some banks like Nomura have already lowered their growth projection in China for the remainder of the year). The second is the Evergrande crisis, where the low press coverage of this event in recent days is striking. Finally, in a military incursion that I estimate would happen late next year or in 2023, China is closing in on an intervention by Taiwan. Today it sent 52 warplanes to the border limit (the most so far since Saturday when it sent 39 planes and that was the record until then), so these events must be observed. Despite the above, there are stocks and ETFs that it seems are oversold and that could present an opportunity (for some ideas in China and others, I invite you to subscribe for free for 30 days in the section "The Speculator's Picks").

On the other hand, looking a little further into the future than this month, Powell ends his Presidency of the Fed in February 2022. The last news from members Kaplan and Rosengreen where it came to light that they traded financial instruments directly benefiting from the decisions of the FED, have tarnished the image of this institution. Related to the above, Senator Elizabeth Warren interviewed Powell last week at a congressional hearing where she called him a "Dangerous man" as the chair of the Fed and gave his vote of no confidence to his reelection. These situations increase the probability of Powell's departure at the head of the Fed and, the increase in expectations of this could add to the uncertainty in the markets in the coming weeks. Some members of Congress are proposing that the debt ceiling be eliminated, to avoid situations like those that are filling the headlines. With a Democratic Fed Chairman (and same-party government), and no debt ceiling, the likelihood that the Fed will finance future "giant" fiscal stimulus packages via open market purchases increases. This obviously increases the risk of higher inflation in the coming years.

The USD as I mentioned in December of last year, has taken a bullish trajectory in recent weeks. The latest events indicated above plus the situation of increasing illiquidity in the market due to the Tapering announcement (which has had an impact of rate hikes throughout the curve in the United States - and in much of the world), help a USD higher in the short term. I keep my initial scenario of a 10 to 25% correction in the S&P500 within the North American summer, although I recognize my mistake in the timing (however, if the correction is maintained, it would have started on September 2nd, date of the historical maximum of the S&P500 so far).

The market has a high "skew" which makes options dealers go out to buy stocks and futures when the market falls and that has put a floor to the falls of the S & P500 so far (considering that the volume traded in options - taking into account its notional value - is today similar to that of its underlying assets). The foregoing, however, does not imply that the bias and trend of the market isn´t downward . Probably, around the option expiration window of Friday October 15th (1 business day before the "x" date indicated above), if a solution for the debt ceiling has not been reached, the market volatility would increase related to this factor.

All the aforementioned helps precious metals rise in price in the short term, just as gold has done in recent days.

ps: since a few days ago, I have at your disposal a service where I share my investment ideas in "The Speculator's Picks" at www.fepic.cl. You can subscribe for free for 30 days. Here you will find the ideas that I am looking at for you to evaluate with your Investment Advisor. The objective is that these ideas are an additional input to the alternatives you see. The good thing is that they come from a former CIO and CEO of Family Offices and who currently manages accounts at www.ifgcapital.cl, so I think it is absolutely worth following them. It is important to mention that these are not investment recommendations, but only interesting ideas that I see in the market (and that I probably have in my portfolio).