‍

Celebrity Deathmatch

‍

Soundbite: Elon Musk is pushing for fiscal prudence, just as Donald Trump did during Obama’s second term. With an ever-increasing fiscal deficit, Treasuries are vulnerable to higher yields that accelerate debt service costs, further widening the deficit. Spending increases will be passed by Congress, so the only hope for narrowing the deficit is greater growth. The prerequisite for growth is stable inflation, which limits higher interest rates and helps promote growth and dampen the inevitable increases in future federal interest rate payments. Lower rates only come with fiscal discipline or an economic slowdown. Congress needs to become a problem solver.

Elon dug up vintage 2011 Donald Trump tweets where he wrote, “Our $17 trillion national debt and the $1 trillion budget deficits are a national security risk of the highest order.” Given that these figures have doubled 14 years later, Musk is calling out Congress for not heeding a 2012 tweet from Trump, which suggested that not voting for a balanced budget should disqualify them from re-election.

Despite how farcical this feud appears, the truth is that our fiscal situation must be resolved, yet we are moving farther away from making tough decisions. Assuming no changes to the tax bill, Wharton’s budget modeling expects a $2.8 trillion increase in the U.S. deficit over 10 years. A $4.3 trillion primary deficit increase is coming just from extending the 2017 tax cuts, offset only partially by $1.8 trillion in spending cuts.

That is not the total deficit, which is defined as the gap between total federal spending and revenues. The primary deficit excludes interest payments to isolate the structural imbalances between tax revenues and government spending. However, that is misleading, because the more debt piles on, the better the chance of spiraling interest costs, because yields should rise with the deficit bloat.

Investors have looked beyond this dilemma and are betting that fiscal stimulus and easy monetary policy produce strong tax revenues. That rosy scenario curbs further deficit widening and keeps the U.S. Treasury market attractive. We are wondering if stocks hovering near all-time highs are prescient or ignoring the inevitable.

‍

Payrolls: When Will Lower Immigration Show Up?

‍

Soundbite: Positive headline payrolls, but weak details. The Household Survey data shows that both the labor force and total employment fell by an outsized 600,000 in May. They cancelled each other out, keeping the unemployment rate relatively unchanged, but that rate still hit its highest level since October 2021. Immigration policy could be the most economically damaging of any of the Trump initiatives because it will naturally shrink a labor force that may already be contracting. Lower labor force growth raises wages and slows growth, resulting in stagflation.

The equity market’s first reaction was jubilation over the increase in non-farm payrolls. We are skeptical because not only has the number of permanent job losers risen to recent highs, but so has the number of workers forced to take part-time jobs because they couldn’t secure full-time employment. The consensus is that those who have full-time employment are safe, yet the number of newly unemployed (under 5 weeks) just registered its third highest monthly total since January 2021.

Just recently, there was quite a cushion in the labor market:

· First, from the extraordinary number of job openings, and by

· The high percentage of firms that were expanding their payrolls. Labor conditions were also supported by

· Sizable immigration flows that kept wages low.

Those positives are gone.

Deutsche Bank estimates that immigration is “down more than 90%...equivalent to a slowing in labor force growth of more than 2 million.” If their calculations prove correct, immigration will become our major economic problem. It will overwhelm tariffs and higher rates that stem from our deficit problems. We are on the lookout for signs of further labor supply contraction and wage inflation, as this could lead to potential stagflation.

‍

In Bostic’s Words

‍

Soundbite: The quarterly letter from Atlanta Fed President Raphael Bostic grants us insight into the upcoming FOMC meeting. The countless tariff questions force the FOMC to be patient. Furthermore, unknown fiscal, regulatory, and tax policy each carry their own set of questions. Given the number of unknowns, the Fed, like the bond market, is on hold unless a crisis occurs.

In the Atlanta Fed’s “Message from the President,” published June 3, Raphael Bostic expects tariffs to boost CPI by 0.8% -1.6%, but that is only for the one quarter of the total CPI basket directly affected by tariffs. It is difficult to estimate the inflationary impact on the rest of the total basket of goods and services because non-tariffed goods may experience supply chain problems, and it is also challenging to model the degree to which consumers will slow their purchases.

Interestingly, their research finds that tariffs from Canada and Mexico account for 45% of the estimated price hikes. Atlanta Fed economists note that the U.S. has “decreased its reliance on Chinese imports since the last trade war mitigates some negative price impacts from new tariffs.” Therefore, a trade breakthrough with Canada and Mexico would be a bigger win than with China.

By Bostic's own account, “Trade policy is a wildcard.” The duration, severity, and consumers’ reaction to tariffs are all unknown. His laundry list of uncertainties probably matches the questions from every other FOMC member:

· Will businesses pass through any input cost increases?

· Will suppliers be willing to absorb anything?

· Will the responses and resilience to the changing environment differ for larger and smaller companies?

· To the extent that firms pass through higher costs, will consumers pay them or will demand decline instead?

This means that the FOMC is faced with a bunch of Russian dolls, because fiscal, tax, and regulatory policy also carry their own specific set of questions. Bostic concludes with “For now, neither I nor anyone has clear answers to any of these questions.”

President Trump complained Friday that the Fed should cut policy rates by a full percentage point immediately. Unfortunately for the administration, any news that supports a healthy economy will prolong unchanged monetary policy. Until unemployment accelerates, the Fed is on hold.

‍

What to Look for This Week

(All times D.S.T.)

1. Tuesday, June 10 at 6:00 a.m. National Federation of Independent Business Optimism Index for May. The NFIB Jobs Report was released, as usual, in the prior week. Job Creation Plans for the next quarter fell sharply, and the number of firms raising compensation hit the lowest reading in over four years, and its monthly drop of seven points was the greatest monthly decline since April 2020, during the height of the pandemic. Because of this weakness, we will look at the rest of this survey on Tuesday, as it was compiled after the confidence boost from the Geneva trade talks.

2. Wednesday, June 11 at 8:30 a.m. the May Consumer Price Index is released. The core CPI has come in at a subdued 2.8% for the last two months, after averaging 3.25% over the prior six months. We will look for any core goods price increases, if any, from the tariffs. The Cleveland Fed Inflation Nowcast expects core CPI to rise slightly to 2.9% in May and 3.0% in June. The May Producer Price Index report is out at 8:30 a.m. Thursday June 12.

3. Tuesday, June 10 through Thursday, June 12 at 1:00 p.m. the U.S. Treasury auctions the 3-year note, the 10-year note, and the 30-year bond, respectively. We will compare the demand for each against the German 10-year Bund auction that is held at 5:30 a.m. on Wednesday, June 11. German institutions, as well as other global fixed income players, may shift some of their Treasury flows to Germany.

FOMC Voters Speaking: Blackout period has started into the FOMC June 17-18 meeting. After last Friday’s Nonfarm payroll data, FOMC participants and staff will be looking at this Thursday’s initial claims data because it does have leading tendencies, unlike the lagging Non-farm payrolls series. The 4-week moving average of claims has risen to 235,000, not far from the high June 2023 prints of 250,000, which remain the worst numbers since 2021.

‍