Open-ended debate over US debt ceiling

Open-ended debate over US debt ceiling ETF SecuritiesOpen-ended debate over US debt ceiling

ETF Securities Fixed Income Research: Open-ended debate over US debt ceiling

Highlights

The December vote for US government funding bill for fiscal 2018 is critical for investors.

  • President Trump’s deal with the Democrats reduces the likelihood of a tax reform.
  • The additional supply of US Treasuries is likely to be partly offset by rising international demand as the global economy recovers.

Open-ended debate over US debt ceiling

The US federal government has already reached the congressionally mandated debt ceiling – the total amount of money that the US government is allowed to borrow to meet its existing legal obligations and interests on its debt – of US$19.8tn in November last year.

In November 2015, the US Congress suspended the debt limit through March 2017. Since March, the US Treasury has been using tax revenues and funds that do not count toward federal debt, the so-called “extraordinary measures”, to meet its legal obligations. These measures were expected to be exhausted by October 2017, forcing President Trump and the Congress to negotiate a deal.

Early in September, President Trump made an unexpected deal with the Democrats to raise the debt limit, including US$15bn of emergency aid after hurricane Harvey hit the Texan coast in late August. The move also temporarily funds the government into early December, so-called “continuing resolution”.

However, the Appropriations funding legislation for 2018 has to pass the Congress vote on December 8 to avoid a government shutdown and a possible default. Therefore, while the debt ceiling debate might go beyond next year’s midterm elections, the December vote is critical for investors.

We believe Trump’s intentions go beyond the immediate need for funding, as he pledged to ”explore ways to depoliticize it [debt ceiling]”, ultimately questioning its legitimacy. For a new long-term debt ceiling bill to pass it needs 60 votes in the Senate. Because the Republicans hold only a slim minority in Senate with 52 seats, a bipartisan deal will be required. The last deal made by Trump with the Democrats suggests the President will compromise with its own party, notably on federal spending cuts, to ensure the debt ceiling will be increased. The political consequences of such a deal has threatened Trump’s credibility within its own camp and his plans on infrastructure spending and tax reforms.

Renewed fears of US fiscal cliff

The “safe haven” status of the US Treasury bills is at stake. The rating agencies Standard & Poor’s and Moody’s warned that a failure by Congress to increase the debt limit in a timely manner would likely imply a review of the current AAA (highest level) rating of the US sovereign debt. The Federal Reserve Bank of Philadelphia’s Partisan Conflict Index has risen to record highs in August along with the risk premiums on US Treasury short-term securities.

Market angst over the debt ceiling has significantly diminished since President Trump signed the temporary budget resolution earlier this month but we expect it to return as we approach December. The spread between 1- and 3-month Treasury bills has tightened after climbing as high as 27bps early September as investors repriced higher the default risk just before President Trump signed the debt relief bill.

In the worst-case scenario, a US default would trigger a disastrous financial crisis as US Treasuries account for about two-thirds of the US repo market. This market played a key role in the recent financial crisis as the difficulties for Bear Stearns and Lehman Brothers to borrow in this market led to their collapse. In the past, the US Congress has always lifted the debt ceiling to avoid default, although often at the very last minute such as after the government shut-down in October 2013.

Increased supply of US Treasuries

The Congressional Budget Office (CBO) projects the US deficit to rise from 3% of GDP to 8% of GDP over the next decade, with growth in revenues outpaced by growth in spending for federal benefits programs (Medicare and Medicaid) due to the aging US population and higher service costs on the government’s debt. Furthermore, the CBO estimated that in the absence of a change in the fiscal trajectory, the public debt would rise from 77% today to 150% of the GDP in three decades.

President Trump’s intended tax cuts and increased military spending would have an even greater impact on the US debt, in particular if there were no spending cuts elsewhere notably in benefits programs unchanged. For example, the tax plan Trump proposed during the campaign would add about US$7.2tn to the debt over a decade, as estimated by the Tax Policy Center.

Those accumulating deficits would significantly increase the issuance of US Treasury bonds and risk premiums are likely rise along with it due to degradation of the fiscal outlook. Some FOMC member such as former Fed’s Vice President Stanley Fischer have warned that “uncertainty about the outlook for government policy in health care, regulation, taxes, and trade can cause firms to delay projects until the policy environment clarifies” and ultimately hurts economic growth. The increased financing needs coupled to the Fed’s normalisation of its balance sheet potentially followed by other central banks might result in a higher supply of Treasuries in years to come.

The US Treasury market is concentrated, with China being the second biggest buyer, after Japan, holding just above US$1tn of US Treasuries (20% of the foreign holding of US government bonds). After declining since 2014, China’s holdings of US Treasuries have strongly rebounded since the beginning of the year as Chinese economy has recovered, the Renminbi appreciates and capital outflows have eased. We expect Chinese holdings of Treasuries to continue to grow towards US$1.3tn – total holdings prior to the currency devaluation in August 2015.

In addition, investors have reported high quality liquid assets (HQLA) shortage resulting from central banks’ large-scale purchase of government bonds. With improving economic conditions, banks assets are likely to rise in tandem with the demand for HQLA to meet the capital requirements under Basel III. Overall, we expect this additional supply to be partly offset in the medium term by an increasing international demand as the global economy recovers.

For more information contact:

ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com

Important Information

This communication has been issued and approved for the purpose of section 21 of the Financial Services and Markets Act 2000 by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”).

The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.

This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States.

This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents.

ETFS UK is required by the FCA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.

Prefer Gold and US Treasuries in March

Prefer Gold and US Treasuries in March

The Flow Whisperer – TAARSS says prefer Gold and US Treasuries in March

Deutsche Bank – Synthetic Equity & Index Strategy – Global

Download the complete report

***Deutsche Bank cares about the ExchangeTradedFunds.com Survey; if our ETF Research team is an important sell-side resource to your investment process, please consider recognizing us in the vote at http://www.exchangetradedfunds.com/vte2610/evote2106.php . Voting closes on March 7th. Thank you. ***

Tactical Asset Allocation Relative Strength Signal (TAARSS) Monthly Update

Top recommendations for March: Gold, US Treasuries, High Grade Credit, US Utilities, and Indonesia.

Recent market relief rally is not consistent with ETF flow trends

Since Feb 11, global equity markets experienced a relief rally of over 5% through the end of February. However the stock market hype was not enough to change investors’ sentiment as reflected in flow trends. Actually, although inflows into safe haven assets such as Gold, US Treasury, and IG Credit, and outflows from Equity both slowed down; the underlying trend of preference for defensive assets over riskier ones remained intact (Figure 1). Therefore we remain skeptic regarding the sustainability of the recent rally, and would rather wait for a clearer signal before calling for a switch back to risk-on mode.

Tactical positioning for March based on TAARSS

  • Overall we continue to see stronger support into defensive assets over risky assets.
  • For Global Equities we recommend to remain on the sidelines, or look for specific themes with attractive support such as Global Natural Resources.
  • For US equity prefer a sector approach. We again favor Utilities and Telecom for March. While for Intl DM equities we prefer Canada.
  • And for EM equities we prefer Indonesia and Latin America on recent support build-up.
  • In Fixed Income, prefer US Treasuries and IG credit over HY credit. In Commodities, prefer Gold on very strong support.

The Synthetic Equity & Index Strategy Team
Deutsche Bank – Equity Research

Prefer defensive asset classes

Prefer defensive asset classes

Deutsche Bank – Synthetic Equity & Index Strategy – Global
The Flow Whisperer – TAARSS says prefer defensive asset classes in February
02 February 2016 (22 pages/ 849 kb)

Download the complete report

Tactical Asset Allocation Relative Strength Signal (TAARSS) Monthly Update

Top recommendations for February: US Treasuries, Gold, High Grade Credit, and US Utilities.

Massive flight to safety during January suggests global equity headwinds to continue in February

ETF flow trends suggest that investors dumped equities in favor of safe haven assets such as US Treasuries and Gold during January (Figure 1). The trends of all of our main equity rotation strategies (markets, regions, US sizes) turned negative at the same time for the first time since August 2011 when markets were experiencing volatility due to the Greek crisis. Furthermore, we have only seen all global equity rotation trends (i.e. markets and regions) turn negative in four occasions since 2007, with each of those occasions being followed by a weak month for global equities recording losses between 3% and 10%.

Tactical positioning for February based on TAARSS

For Global Equities we recommend to avoid them altogether (particularly EM), or prefer DM ex US (mainly Europe and Asia Pacific) exposures.

  • For US equity prefer a sector approach. We favor Utilities and Telecom for February. We highlight Energy as a possible recovery trade.
  • For Intl DM equities prefer global regional allocations (e.g. EAFE-like) instead of other sub regions or country exposures.
  • For EM equities we see weakness across the board and recommend steering away from them in February.
  • In Fixed Income, prefer US Treasuries and IG credit over HY credit. And in Commodities, prefer Gold.

Prefer US Equities into year-end

Deutsche Bank – Synthetic Equity & Index Strategy – Global The Flow Whisperer – TAARSS says prefer US Equities into year-end

07 December 2015 (22 pages/ 814 kb) The Flow Whisperer – TAARSS says prefer US Equities into year-end

Download the complete report

Tactical Asset Allocation Relative Strength Signal (TAARSS) Monthly Update

Top recommendations for December: US Broad, DM Global Regional, and US Technology equities.

ETF flow trends showed strong support from investors to US and Global DM regional equities, but not to DM countries

During November, equity ETFs experienced the most significant flow trends. US and DM equities both showed positive support, while EM flows signaled weakness. However, the divergent trends within DM equities caught our attention the most. ETFs tracking Global DM Regional exposures (think EAFE or World ex US) attracted very strong and consistent inflows; while, on the other hand, ETFs tracking specific DM countries experienced consistent outflows suggesting that investors are concerned with specific country risk outside the US (Figure 1).

Tactical positioning for December 2015 based on TAARSS

  • Prefer equities over fixed income and commodities into year end.
  • For Global Equities prefer positions in US, and DM equities; avoid EM.
  • For US equity exposure prefer broad market cap exposure with a tilt to domestic cyclical sectors such as Tech.
  • For Intl DM equities prefer global regional allocations (e.g. EAFE-like) instead of other sub regions or country exposures. Stay neutral to Europe and Japan, and away from Asia Pac ex Japan. Continue to implement Europe via regional exposures rather than country allocations.
  • For EM equities, we see pressure from flows across the board, and downside risk from a potential Fed hike. We recommend staying away.
  • In Fixed Income, US Treasuries continue to suggest weakness. Corporate credit (IG, HY, Sr Loans) also seemed weak. There may be some opportunities in EM Debt, however.

The Synthetic Equity & Index Strategy Team
Deutsche Bank – Equity Research

TAARSS says prefer Fixed Income in Q4

Deutsche Bank – Synthetic Equity & Index Strategy – Global – TAARSS says prefer Fixed Income in Q4

The Flow Whisperer – TAARSS says prefer Fixed Income in Q4 and extend duration
05 October 2015 (23 pages/ 1392 kb)

Download the complete report

Tactical Asset Allocation Relative Strength Signal (TAARSS) Monthly Update

Top recommendations for September: US Treasuries, and US, Europe, and Japan equities.

Market review

Risk assets plunged, while safer ones found support in September. Global equities (ACWI) and Commodities (DBC) both plunged by 3.4%, while US Bonds (AGG) recorded modest gains of 0.81%.

TAARSS rotation strategy monthly and quarterly performance review

Quarterly and monthly TAARSS strategies were mixed. Quarterly strategies underperformed; while most monthly strategies outperformed their benchmarks.

Tactical positioning for October 2015 and Q4 based on TAARSS

ETF flow trends clearly suggest a defensive positioning into year end. Our model suggests a clear preference for fixed income over equities, and away from commodities in Q4. In addition, our model suggests an increase in the duration of fixed income portfolios by adding long and intermediate exposure for the same period.

For the month of October, TAARSS suggests a positioning favoring US Treasuries, and investment grade over high yield credit within fixed income. For equity positions a defensive approach with a preference for DM and the US over Emerging Markets is recommended. Within the US, a broad all-cap or equal weighted exposure may be more suitable; while in Intl DM, Japan or European regional allocations seem to have better investment demand support. In EM countries, weakness in China and India remained, but seemed to be fading; while the significant selling pressure in Indonesia suggests investors should stay away. In general, specific country risk outside Japan and the US should be avoided in order to benefit from diversification particularly during times of higher volatility. In the commodity space we don’t see strong signals worth highlighting. See Figure 13 and Figure 14 for full allocation details for the month of October and Q4.