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The author is an analyst at NH Investment & Securities. He can be contacted at [email protected] — Ed.
While Yellen's main goal for 2023 was to preserve the TGA's cash reserves despite the large budget deficit, her goal for 2024 is to improve the budget balance by using tax revenue surpluses, which would remove the risk of rising yields, which was a major risk factor this year.
Yellen's Intention: Ensuring Fiscal Sustainability, Not Spending Expansion
We believe the key news provided to the market last week was not the January FOMC meeting, but the Treasury's Quarterly Borrowing Schedule (QRA), the main takeaways from which were 1) a reduction in bond issuance contrary to market expectations, and 2) plans for net redemptions of T-Bills ($245 billion) from April through June.
Rather than focusing solely on the results, we recommend considering the background that allowed for the reduction in issuance. The US GDP growth rate for Q4 2023, announced after the last QRA (October 2023), significantly exceeded market expectations. This development suggests that government revenues in the previous quarter were also below expectations.
The key point here is how the government will use the revenue surprise. Chair Yellen intends to use the increased tax revenue to improve the fiscal balance, not to spend. In particular, with regard to the redemption of short-term government bonds, reissuing them at a lower interest rate after redemption will improve the fiscal balance, given the expected Fed interest rate cut in the second quarter of 2024. In other words, Chair Yellen aims to ensure fiscal sustainability, not to increase spending.
The expansion of the government's fiscal deficit has put strong upward pressure on US GDP in 2023. However, this quarter's QRA suggests that the contribution of government spending may slow in 2024. From the market's perspective, as fiscal contributions decline, this means that the role of monetary authorities in supporting the economy will increase. Despite the withdrawal of expectations for an early rate cut, market expectations for a rate cut after Q2 2024 are rising. We note that the risk of rising yields due to fiscal policy, which was a major risk factor this year, has been withdrawn.
January's impact repeats for the third year in a row
Every January, the Fed adjusts its statistics to reflect changes in population estimates. The problem now is distortions from seasonal adjustments made after the COVID-19 crisis. As a result, the number of new jobs in January 2022 was 467,000, 3.74 times the forecast (125,000), in January 2023 it was 517,000, 2.75 times the forecast (188,000), and in January 2024 it was 353,000, 1.91 times the forecast (185,000).
While there is no reason to discount the big surprise in January's employment numbers, we recommend at least taking these statistical features into account.
We have consistently maintained that a recession is not necessary for this tapering of inflationary pressures. While this employment data eliminates expectations of a rate cut in March, given our outlook for the Beveridge curve, we maintain our expectation of a Fed rate cut in Q2 2024.
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