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End-Of-Month Flows

Updated: May 6, 2023

I strongly believe that the US government's spending program is the driving force behind economic growth in the country, which has major implications for the global economy as a whole. Fortunately, the US is known for its transparency, and its data is helpful for analysts like me who want to track spending patterns. By staying informed, investors can take advantage of market shifts and adjust their positions accordingly.

Yesterday, the ES S&P futures contract closed above the important 4000 level, indicating a possible shift in directional bias. If you're a bear, you might sell the rally that's likely to follow today's NFP data. But if you're a bull, you might see this sweep of a swing low as a buying opportunity, as the price is likely to test the high of the range next.

This is what creates a market, the push and pull of money in both directions.

According to the AAII sentiment data, the average American investor is currently bearish. However, historically, above-average market returns have followed unusually low levels of optimism. That's why it's usually wise to go against the retail investor, who is often considered the "dumb money."

Social media sentiment is also negative, with many analysts and fund managers discussing the failing bank situation. However, these discussions often offer no solutions on how to avoid getting trapped in a bad trade. While the situation is concerning if you recently bought the XLF (financial ETF), JP Morgan and a few other Tier-1 banks are benefiting from the demise of smaller banks, which keeps the money in a closed system.

What makes me bullish, other than going against the retail investor?

My main thesis is that the US government's deficit spending has been rising since the start of this month. Initially, I was worried that the tax drain from April and the Debt Ceiling limit would keep spending in surplus for longer. But this year, there's less uncertainty, smaller rate rises from the Fed, and a smaller tax drain period. As of May 3rd, the deficit spending was at $85.8 billion, and the surplus lasted for only 11 days, compared to last year's 21 days. Although the S&P in 2022 continued to push lower into June, there's a chance that the bottom isn't in for this year's seasonal adjustment. But overall, things are looking more positive.

The main worry is the debt ceiling, and US Treasury Secretary Yellen has warned that there could be a default on payments by early June if Congress doesn't reach a deal. This is ridiculous political brinkmanship, but it's not the first time things have come down to the wire.

The Treasury General Account has been drained, and they are operating under special measures to conserve cash. Treasury Secretary Yellen can only spend what she receives in taxes currently and has had to dip into certain pots to rob Peter to pay Paul.

The specific measures that the Treasury can take include:

  1. Suspending investments in certain government retirement funds: The Treasury can suspend investments in certain government retirement funds, such as the Civil Service Retirement and Disability Fund, to free up cash that can be used to meet the government's financial obligations.

  2. Delaying payments to certain government programs: The Treasury can delay payments to certain government programs, such as the federal employee health and life insurance program, to conserve cash.

  3. Suspending the sale of certain government securities: The Treasury can suspend the sale of certain government securities, such as State and Local Government Series (SLGS) securities, to avoid exceeding the debt limit.

  4. Drawing down the Treasury's cash balance: The Treasury can draw down its cash balance, which is the amount of money it has on hand, to finance the government's operations.

President Biden has taken a firm stance in refusing to negotiate with Republicans over the debt ceiling. He believes that the ceiling must be lifted without any restrictions to ensure that America is able to meet its financial obligations. On the other hand, House Republicans recently passed a comprehensive bill that seeks to increase the debt ceiling by $1.5 trillion, but only in exchange for significant spending restrictions. In the event that he is required to, Biden has stated that he will veto this legislation.

April's tax collection came in below the previous year but is still relatively high compared to the previous 5 years of data.

Debt issuance has been reducing since January, but lifting the debt ceiling would allow Yellen to issue more debt, sell it, and spend the cash.

As a side note, talk of minting a $1 trillion dollar coin makes headlines each time we get close or at the debt ceiling. Here is how it would work from Warren Mosler.

Currently, the Republicans are forcing the Democrats to find ways to fulfill the spending obligations set out in their budget last October while not increasing the amount of money available to do so. Avoiding wasteful spending is the key, but they're being helped by the Fed rate.

Interest paid on the US Treasury Securities is rising at a rapid rate as can be seen from February 2023 payment, compared to the previous 6 years.

This week the Fed once again lifted interest rates by 25bps and from the chart above, we can see that even though the change in rate hikes is plateauing, the interest payments are exponentially growing. This money finds its way back into the economy and is acting as fiscal support.

Net spending was increasing from December 2022 through to March 2023, but April has reversed this trend for now. The year-over-year difference can be seen above and this fiscal year is the worst April spending in the last 4 years. But still relatively high compared to 2016-2019.

On the 3rd of May, there was a Supplementary Social Security payment with three more payments due over the next few weeks.

Looking back to the time of the Great Financial Crisis it is obvious to see that the trend in monthly payments for Social Security in the USA is rising. As the Baby Boomer generation comes into retirement the population is going to tap this resource more and more. The parties on both sides of the aisle are going to want to keep this cohort happy, so we should expect greater payments into the economy over time and the overall net spending to hit above $7 trillion per year. This is a fiscal boost and will help support the stock market.

With regards to the economy and what happens next, the Atlanta Fed GDPNow indicator just ticked higher. This comes despite the bad news around the banking sector, the war in Ukraine, the persistent inflation, and rates higher for longer by the Fed.

The US unemployment rate is low and there are still more job openings than available workers. So tax revenue should remain stable. One thing helping to lift the GDP is the decreasing trade balance deficit, which is a drag on GDP. Americans are starting to import less while exports are rising.

The net effect is that the trade balance is now -$64.2B and the part of the GDP equation which is usually negative is still negative but getting smaller. GDP = private consumption + gross private investment + government investment + government spending + (exports – imports)

One area I am keeping an eye on is the net exports of Crude from the USA. The more they sell, the more they receive back US dollars, which goes some way to supporting the greenback.

The rising price of Oil was pushing inflation higher, and with the combined rising Interest Rates increasing the cost of everything, compounded with a supply chain disaster from COVID, it is no wonder inflation couldn't stop at 2% and is taking a while to get back down.

The CPI has been dropping in line with the falling oil price and is steadying itself around the value area of $65-$70 per barrel.

Another thing I will be looking at in the wake of the biking fiasco is the amount of credit being issued by the banks.

Around the time of the ATHs in the stock markets, the amount of credit issued by the Commercial Banks had reverted back to the mean. I am sure there is a correlation between businesses opening up, asking for credit to purchase inventories, and then not needing credit as they did in 2020. And if we were to draw a line through the average from 2010 until 2023 I am sure the current level of credit would be around the right level.

If banks have to hold more reserves though, they will be restricted on the amount of new loans they can create assuming the actual cash is flowing out of the banks. If the deposits are net the same just in different institutions, we should be all good.

To conclude, the debt ceiling is the only thing that I am worrying about currently, but I do

expect them to not raise the ceiling or potentially suspend it. The war in Ukraine and Social Security payments rising will keep putting pressure on the government, and Congress ét al to make more money available so that they can fulfill the rest of the budget. I fully expect the stock markets to rise on the news that the debt ceiling has been lifted. All else staying equal.


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