What Happened to All that Money?

Tax Receipts on Ozempic

The Congressional Budget Office (CBO) reported that tax revenues for April were almost 20% lower than expected, and it forced the Treasury to borrow more than was originally planned. It was expected that a strong stock market would have generated hefty capital gains tax payments and help overall revenues, but tax payments were disappointingly thin. The previous year had a -19% performance in the S&P 500 Index, compared to a +24% performance during 2023. U.S. taxpayers reduced their tax burden owed to the IRS in April 2023 thanks to capital losses in 2022. Last year, investors paid much more when filing their April 2024 tax returns due to capital gains from last year’s profits. While the last 6 month period showed a $60 billion smaller deficit than the same period a year ago, it was not a reason to celebrate because it should have been even better.

The CBO is concerned that due to the added costs associated with disaster loans and outstanding student loans, we are facing larger deficit pressure for fiscal year 2024 (ending in October) compared to 2023. That translates into bigger Treasury auctions to compensate for the larger budget shortfall. A bigger supply means higher interest rates to entice investors to buy bonds.

A budget deficit exceeding $1.5 trillion is not a welcome event and will keep longer maturity Treasury bonds at high rates. This is unwelcome news for anyone hoping that automobiles and homes will become more affordable to buy through borrowing. Remember, this is happening against the background of a strong economy—the situation would get far worse for the country in an economic downturn because it would be met with even bigger government spending to help consumers.

What the Banks Are Saying

A particularly important economic survey of bank lending activity is conducted by the Federal Reserve every quarter, and unfortunately, it continues to report that banks are tougher on granting loans to businesses and, to make matters worse, are seeing weak demand for loans. The Fed’s Senior Loan Office Opinion Survey on Bank Lending Practices (SLOOS) looks at loan terms and demand for those loans across businesses and households, and the most recent report covered the first three months of the year. Regarding households, banks are seeing weak demand across all loan categories, including mortgages. Bad news for consumers: banks have tightened lending standards for home equity lines of credit and, more importantly, for credit card, auto, and other consumer loans.

Specifically, banks are raising their minimum credit score requirements across credit card, auto, and other consumer loans. Banks expressed that they are increasing spreads of interest rates over the bank’s funding costs, meaning that the few consumers who met the higher credit score thresholds were paying more for those loans than before.

While employment is strong, the economy is not vulnerable. However, Friday’s University of Michigan Consumer Sentiment survey collapsed to 67 in May from 77, as those polled expressed concern about employment prospects and interest rates. Employees are feeling much less positive about the job market; therefore, if unemployment spreads, consumers will not be able to rely on any safety net from banks. In fact, at the sign of any downturn, these banks will become even more risk-averse. In the same way that the budget deficit is dangerously high despite a strong economy, banks are conservative despite a good labor market. If economic weakness appears, this is a very vulnerable situation for risk assets (and for consumers and businesses).

What Copper Is Saying

Copper is an industrial metal and is a good barometer of investor sentiment for global growth. Lately, it has been on a tear, reflecting optimism over renewed global growth led by the U.S. and supported by the hope for a bottoming out in the Chinese economy. It has also seen demand from those who want to profit from sustained inflationary pressures. My preferred measure of overheated sentiment is to look at copper’s price change over the last three months; anything over 25% is a sign of extreme sentiment. Copper has pushed into that oversold territory, and furthermore, copper is near its all-time highs.

If copper starts trading in a tight range and does not fall significantly, it is a sign of consolidation before another rally, which is bullish for the world’s economic outlook. However, if it does reverse from Friday’s high, it is a warning sign that economic conditions, already weighed down by the overhang of tight credit conditions, could slow down appreciably. This would signal that stocks could face a reversal and would be a sign to allocate capital into 2-year treasuries, currently yielding 4.5%. No alarm yet, but we are on alert.

What to Look for This Week

1. The New York Fed 1-year Consumer Inflation Expectations are released at 11:00 E.S.T. today, May 13. The survey takes on added importance following last Friday’s University of Michigan year-ahead inflation survey jumping from 3.2% to 3.5%. Every single Federal Reserve voter has mentioned that low inflation expectations are a sign of confidence that the Fed is doing a respectable job. The series stood at 3.4% in December and has fallen to a low of 3.0% for each of the last four months in the new year. If the data continues at 3.0%, expect Fed speakers to be encouraged by it, depending on what happens with CPI this Wednesday.

2. The National Federation of Independent Business (NFIB ) releases its Economic Trends survey for April before the U.S. markets open on Tuesday, May 14. The April survey will be important because it is on the quarterly cycle that has twice as many businesses responding. Our key focus will be on the interest rate paid on short-term bank loans, which was at a multi-year high of 9.8% in March. The larger January survey reported the number as “only” 9.0%, so the April reading will be important.

3. Fed Chair Powell speaks at a moderated discussion at the Foreign Bankers Association in Amsterdam at 10:00 E.S.T. Tuesday, May 14. He speaks a day before the highly anticipated CPI inflation report for April is released on Wednesday. FOMC voter Michele Bowman speaks that afternoon, and she has been outspoken about waiting for “a number of low inflation readings” before even considering cutting rates, so we will be on the lookout for her post-CPI opinion.