We’re sending this on the Sunday bookended by the week that celebrated America’s veterans and the week of the traditional American gathering of Thanksgiving. We wish all readers goodwill and safety in their travels.
Let’s take a deep breath and tackle the volatility in financial markets caused by Washington’s political dysfunction.
Here’s the 10-year credit default swap (CDS) on the United States as it appeared before the 11th hour budget shutdown deferral agreement. Washington has again kicked the can down the road. Since the deal, not much has changed in the global pricing of CDS on the US government. Note that the pricing reached a level which exceeds that at the time of the Biden-McCarthy handshake last May. For my earlier commentary on the cost of dysfunction, see our July 30 piece, “The Cost of Debt Ceiling Crisis.”
Day-to-day movements in stock prices, or commodity prices, or currency ratios, or other daily fluctuations have nothing to do with the heart of the matter, which is the threat to the credit rating of the United States by the political dysfunction in Washington. Specifically, that dysfunction is now originating in the House of Representatives.
The US stock and bond markets are ignoring this risk as they continue to act as if a real fix will occur. So, now we get to next year before the charade begins all over again. Q4U: Will Johnson fall victim to the same nefarious political force as McCarthy? Has anything really changed, except that the politicians are afraid of Americans’ wrath if a shutdown occurs during the holiday season?
On Friday, Nov. 10, Moody’s issued a warning on the creditworthiness of the United States (“Moody’s sends a warning to America: Your last AAA credit rating is at risk,” https://www.cnn.com/2023/11/10/economy/moodys-warning-us-aaa-rating/index.html). I believe a downgrade is coming; and when it does, the US will have succeeded in losing its AAA status at all three major credit rating agencies: Standard & Poor’s in 2011, Fitch earlier this year, and Moody’s soon to join them. That means some of the sovereign states’ credit will be more highly rated than the federal government’s is. That is correct: The sovereign State of Maryland could have a higher credit rating than the United States of America.
Leave the borders of the US and the scene is different. Global financial markets are pricing this risk with CDS. They are doing this for America just as they do it for other countries around the world and for corporations that use debt in their global financing.
Please remember that every single basis point of elevated interest rates caused by political dysfunction means a permanent shift of America’s federal financing cost in the amount of $2.7 billion annually. That is a one-basis-point change on $27 billion of aggregate tradable federal debt. We ignore the federal debt held by any federal party, since that is interest which we are paying to ourselves. Since January, the rise in 10-year CDS suggests that the political dysfunction has permanently raised the cost of financing America’s government by about $100 billion a year (40 basis points times $2.7 billion for each basis point equals $100 billion-plus per year.)
Remember that the higher federal cost impacts the entire array of $70 billion in US dollar-denominated debt. Some sectors are impacted more than others. Foreign government-issued debt may not be impacted at all. But home mortgages in the US are priced (yield) in conjunction with the costs of borrowing by federal agencies like Fannie Mae. So, if the dysfunctional Congress causes the US to pay more for money, and therefore federal agencies to pay more to borrow, the impact is for the Congress to have raised the mortgage payment of nearly every new home buyer in the United States. In an op-ed for the New York Times, Westwood Capital’s Daniel Alpert blames the Fed for the housing crisis and for the higher mortgage rates (“The Fed Has Put Our Housing Market in Jeopardy,” https://www.nytimes.com/2023/11/14/opinion/federal-reserve-housing-market.html). He is only partially correct.
I would add to his commentary the cost of congressional dysfunction, which has raised the interest rate paid by the housing finance agencies like Fannie Mae. Using the CDS pricing for an estimate, we can suggest that a 30-year conventional mortgage in America today has about 40 basis points of its interest rate originating with the House of Representatives. Forty basis points on a $400,000, conventional, 30-year mortgage means $1600 a year or about $130 per month. That’s right! Gaetz and Co. – the “eight crazies” (as they were termed by former Speaker McCarthy) – have raised the average mortgage payment for a new home buyer by about $130 per month.
So, all new home buyers, real estate sales agents, homebuilders, materials suppliers, subcontractors, and everyone else who is interested in the housing sector of the United States: Please pay attention to this calculation. Federal budget dysfunction (debt ceiling fight, shutdown warnings, failure to appropriate money beyond a few weeks or months) has a cost, and it hits you squarely in your pocketbook and in your business. For the wealthy investor, a high-grade tax-free housing authority bond new issue was over a 5% yield this week even as the US treasury bond market rallied so robustly.
UGH! For new home buyers. Good news for the highest tax bracket investor.
Another example is the dysfunctional attachment in the House of the reduction in IRS enforcement to the allocation for the defense addition to Israel war assistance. There is strong bipartisan support for helping Israel fight Hamas and Hezbollah and others that have tried to destroy the state and that attacked, raped, killed, maimed, and otherwise terrorized Israeli citizens and visitors from around the world last month. The Hamas War caused the internal displacement of about 200,000 living in Israel, and another 360,000 citizen soldiers were called up and are now fighting the war. So, what did the dysfunctional House do? It tied the funding to the reduction of the enforcement provisions of the IRS. By doing so it produced a bill that would expand the deficit. The impartial CBO estimate is that the bill would cost the government a net $27 billion over the next decade (“House GOP passes Israel aid bill,” https://www.politico.com/live-updates/2023/11/02/congress/israel-bill-passes-00125127). Note that this happened within a day of the announcement that the IRS had won a 9-figure enforcement action against a taxpayer trying to dodge taxes (“IRS Wins $109 Million Court Case, Defeats ‘Project Soy’ Tax Maneuver,” https://www.wsj.com/politics/irs-wins-109-million-court-case-defeats-project-soy-tax-maneuver-1cf1dc86?st=dqifsjkocuoqpfw). See also “I.R.S. Deploys Artificial Intelligence to Catch Tax Evasion,” https://www.nytimes.com/2023/09/08/us/politics/irs-deploys-artificial-intelligence-to-target-rich-partnerships.html.
In private wealth management business firms like Cumberland, we read the internal industry trade publications. They are talking about the IRS’s renewed enforcement of tax collection for the top 1% or 2% of taxpayers (“IRS Amps Up Enforcement on the Wealthy,” https://www.wealthmanagement.com/high-net-worth/irs-amps-enforcement-wealthy). Why do they concentrate on these folks? When the judge asked Willy Sutton, “Why do you rob banks?” he said, “Judge, I rob banks because that’s where the money is.” So, ask yourself a basic question. How did a reduction in the IRS enforcement budget get attached to a proposal of the House “Chaos Caucus” when the House was in debate over a defense appropriation for an ally in the Middle East who is engaged with an enemy bent on destroying their country and the entirety of Judeo-Christian Western culture and the Western alliance of nations? Somehow, the IRS funding doesn’t seem appropriate as a condition attached to a bill that has not a chance of passage in the Senate and would have a certain White House veto.
Readers can fill in the rest for themselves.
UGH!
Lastly, the Tuberville charade continues to undermine the defense capability of the United States. This Senator is the single objecting vote to the confirmations of about 450 US military appointments. Politico reported some of these votes were 95-1. It only takes one objection unless there is a 60-vote override of the senatorial rule Tuberville is using. The criticism of Tuberville in the US Senate is now vitriolic and comes from his own party leader Mitch McConnell and from other Republicans as well as from Democrats. (See “Playbook: Tommy Tuberville vs. everybody,” https://www.politico.com/newsletters/playbook/2023/11/02/tommy-tuberville-vs-everybody-00124952. Also, “Tuberville staffer asks anti-abortion groups to float primaries against Republicans who oppose military holds,” https://www.politico.com/live-updates/2023/11/02/congress/tuberville-staffers-anti-abortion-group-ask-00124994.) This issue is no longer about red or blue. Tuberville has become an obstinate disaster for America, in my opinion. What a way to demonstrate support on Veterans Day!
Most of the senators (both parties) want this to stop. The country wants this to stop. Tuberville will eventually be overridden or relent. Q4U: Will the people of Alabama decide this is a failed policy? I have personally spoken with military veterans with roots in Alabama, and they are in the leadership of the Republican party. They know Tuberville. They say they have abandoned him. Time will tell.
UGH!
Note that the House has now moved the defense appropriations budget item into the category of discretionary spending. They didn’t do this with any official announcement. They did it by not appropriating defense separately, as has been done previously by both Republicans and Democrats. In my opinion, this is just plain craziness. Look around the world. Does anyone think for one moment that this is a good time to play games with the federal defense budget? The few troublemakers (the “eight crazies”) who hold the majority of the House hostage are playing with fire. The shutdown avoidance is a temporary fix; it did not raise the defense budget. It only continued the funding at the current level. The issue is still ahead after the Congress returns in January.
We wish readers a Happy Thanksgiving.
Please think and talk about the safety and security of the United States as we gather for this annual American tradition.
Disclosure: We are overweight the US aerospace-defense sector in the US Equity ETF portfolio. This could change at any time.
David R. Kotok
Co-Founder & Chief Investment Officer
Email | Bio
Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.
Sign up for our FREE Cumberland Market Commentaries
Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.
