Treasury Curve Inverts As Trump Slams Dems For Forcing Shutdown

Early in the week, anxiety over a government shutdown appeared to ebb as the short-term Treasury Bill market began to "normalize", but following the tax-reform "win", President Trump is accusing Democrats of trying to force a government shutdown...

House Democrats want a SHUTDOWN for the holidays in order to distract from the very popular, just passed, Tax Cuts. House Republicans, don’t let this happen. Pass the C.R. TODAY and keep our Government OPEN!

— Donald J. Trump (@realDonaldTrump) December 21, 2017

...And the Bill curve has shifted notably more inverted...

While there are obviously year-end liquidity impacts involved too, it appears market anxiety is building as perception grows that Dems may move to stunt the Republicans" momentum from their "victory" on taxes.

Government Shutdown Looms Amid Clash Over "Dreamers" Fate

In an announcement that will provide some measure of relief for T-bill traders and others who are skeptical about Republican lawmakers" ability to compromise with their Democratic colleagues, the Republican House leadership said Tuesday they would bring a stopgap bill to extend funding at its current levels - and preserve funding for a popular child health-care program - until Dec. 22. Otherwise, the current continuing resolution would expire on Friday, tilting the federal government into its first shutdown since 2013.

The compromise leaves much to be desired, however, and a workable, long-term spending compromise will unlikely be reached, which is making markets nervous. As we reported yesterday, the T-bill market has once again been under pressure, with the Dec 14 Bill the traders" focus for now:

Lawamakers" unwillingness to compromise on this bill, however, is due to one policy demand that Democrats have staked their political future on, but Republicans see as tantamount to amnesty: Enshrining DACA, or DREAM Act, protections into law.

The deal look ready to go in Setember when Trump annoounced he"d struck a deal with "Chuck and Nancy" to pass a continuing resolution in exchange for a series of Democratic compromises on imigration enforcement while Trump would fight to push Congress to authorize the DACA privileges. Trump had canceled an executive order granting those protections earlier this year.

However, a few weeks later, Trump went back on his word, proposing that the final legislation include funding for his border wall - something Democrats had never agreed to. Meanwhile, some Republicans have taken a hard line on the DACA protections, saying there"s "no way" they"d be included in a spending bill before the end of the year. More from Bloomberg:

John Cornyn of Texas, the Senate’s No. 2 Republican leader, said Monday that talks with Senate Democrats over combining new border security measures and deportation protections are at an impasse. Cornyn said he sees little chance for resolution before the year is over, pushing the matter into early 2018.

 

He also told reporters that “no way” would he back combining such a package with a must-pass year-end spending deal designed to keep the government open, a key demand of Democrats to get their needed support to move it through the Senate.

 

Speaking on the Senate floor, he accused Democrats of a “hysterical and cynical ploy” of threatening to trigger a shutdown over the matter. Republicans are angling for a two-week stop-gap measure to get past a Dec. 8 deadline when agency spending authority lapses, with the potential for a second such measure later in the month that extends into January. Democrats haven’t agreed to those terms.

Widening the divide, many powerful Democrats are demanding these protections be enshrined in law by the end of the year. 

Senator Richard Durbin of Illinois, the No. 2 Democratic leader, said later that he continues to insist that Congress act this year to address the needs of the young immigrants, brought to the U.S. by their parents when they were children. Their deportation protections were put in place by President Barack Obama and temporarily extended by Trump until early March. Ending them will affect 1,000 young people each day over two years if the deadline is reached, Durbin said.

 

“I want it done this year,” Durbin said. “This calendar year.”

At least one Republican who’s in favor of keeping the protections has said it’s possible they pass by the end f the year – just not as part of the bill to reauthorize spending.

The protection for the those covered by Obama’s Deferred Action for Childhood Arrivals program, or DACA, has been up in the air throughout the first year of Trump’s presidency. Trump in September agreed with Senate Minority Leader Chuck Schumer of New York and House Minority Leader Nancy Pelosi of California to move a border security bill by year’s end, and pair it with protections for the immigrants. He has since backed away from it.

 

A Senate Democratic aide familiar with the negotiations said that Republicans proposed a plan for a dramatic increase for border resources, some cuts to the number of legal immigrants and only temporary protections for the young immigrants. Durbin put forth a counter proposal with more modest border resources, combined with a permanent DACA fix and a pathway to citizenship for the immigrants.

Given the rancor these negotiations have instilled in both Democrats and Republicans, it’s also unlikely the two sides will be able to compromise on issues like preserving Obamacare subsidies, funding for Planned Parenthood and disaster relief spending.

For now, at least, Republicans have cobbled together a stopgap - though it"s still unclear if this will have the votes to pass the senate. The plan maintains the current federal spending levels but includes a provision to ensure that states are not forced to suspend the popular Children"s Health Insurance Program, which annually provides health insurance for nearly 9 million children in low-income families.

"This bill, one without any controversial policy riders, will continue government funding and give the House and Senate time to complete their work on a long-term solution," McConnell said on the Senate floor Monday.

"It will keep the government open and functional, and it includes critical resources for our national defense and to give states certainty to continue the Children"s Health Insurance Program while the bipartisan work on CHIP reauthorization continues," he added.

McConnell summarized the republican position best, noting that that Congress has until March before those covered by the Deferred Action for Childhood Arrivals (DACA) program lose protections from the program President Trump is ending.

“I don’t think the Democrats would be very smart to say they want to shut down the government over a nonemergency,” McConnell said on ABC’s “This Week.”

Of course, the Democrats will claim that it is an emergency, and certainly a worthy cause for government shutdown, just as Trump enjoyed his biggest legislative victory to date.

As the Hill pointed out, Pelosi and Schumer said in a statement accepting an invitation to meet at the White House on Thursday that a “bipartisan deal” could be found to pass the “DREAM Act along with tough border security measures.”

“There is a bipartisan path forward on all of these items,” the two said in the statement, which also emphasized the need to boost defense and nondefense spending and provide disaster relief.

* * *

Meanwhile, on Tuesday morning, as touched upon up top, the House Republican leadership said it was forging ahead with a stop-gap bill to keep the government funded through Dec. 22 and avoid a shutdown, despite a Monday night push from the conservative Freedom Caucus to move the date past Christmas. Lawmakers emerged from a House GOP conference meeting on Tuesday morning indicating that leaders are leaning toward a two-week continuing resolution (CR).

“Leadership is locked in on Dec. 22,” Freedom Caucus Rep. Andy Biggs (R-Ariz.) told The Hill.

The Freedom Caucus had protested the strategy and held up a vote on a motion to go conference with the Senate on tax legislation Monday night until they got assurances from leadership that they would consider a longer CR. But leaders appear to be sticking with their original plan.

* * *

Still, the question remains: How long can lawmakers keep doing this before they get tired of pretending they have some deal in the worlds, and realize that a permanent solution is impossible and usher in the first shutdown since 2013?

The Greatest Fear Today: The Lack Of Fear

Authored by James Rickards via The Daily Reckoning,

Market crashes often happen not when everyone is worried about them, but when no one is worried about them.

Complacency and overconfidence are good leading indicators of an overvalued market set for a correction or worse. Prominent magazine covers are notorious for declaring a boundless bull market right at the top just before a crash or correction.

October 19 saw the thirtieth anniversary of the greatest one-day percentage stock market crash in U.S. history - a 22% fall on October 19, 1987. In today’s Dow points, a 22% decline would equal a one-day drop of over 5,000 points!

I remember October 19, 1987 well. I was chief credit officer of a major government bond dealer. We didn’t have the internet back then, but we did have trading screens with live quotes. I couldn’t believe what I was watching at first, but by 2:00 in the afternoon we were all glued to our screens.

It was like being a passenger on a plane that was crashing, but you had no way out of the plane. Our firm was fine (bonds rallied as stocks crashed), but we were concerned about counterparties going bankrupt and not being able to pay us on our winning bets in bonds.

What’s troubling is that a lot of commentators said that the kind of crash that took place in 1987 couldn’t happen today and that markets were much safer. It’s true that circuit breakers and market closures could temporarily halt a slide better than we did in 1987. But those devices buy time, they don’t solve the underlying fear and panic that causes market crashes.

In any case, when I hear market pros say “It can’t happen again” it sounds to me like another market crash is just around the corner.

The problem with a market meltdown in today’s even more deeply interconnected markets, is that once it strikes, it’s difficult to contain. It can spread rapidly. Likewise, there’s no guarantee that a stock market meltdown will be contained to stocks.

Panic can quickly spread to bonds, emerging markets, and currencies in a general liquidity crisis as happened in 2008.

Why should investors be so concerned right now?

For almost a year, one of the most profitable trading strategies has been to sell volatility. That’s about to change…

Since the election of Donald Trump stocks have been a one-way bet. They almost always go up, and have hit record highs day after day. The strategy of selling volatility has been so profitable that promoters tout it to investors as a source of “steady, low-risk income.”

Nothing could be further from the truth.

Yes, sellers of volatility have made steady profits the past year. But the strategy is extremely risky and you could lose all of your profits in a single bad day.

Think of this strategy as betting your life’s savings on red at a roulette table. If the wheel comes up red, you double your money. But if you keep playing eventually the wheel will come up black and you’ll lose everything.

That’s what it’s like to sell volatility. It feels good for a while, but eventually a black swan appears like the black number on the roulette wheel, and the sellers get wiped out. I focus on the shocks and unexpected events that others don’t see.

The chart below shows a 20-year history of volatility spikes. You can observe long periods of relatively low volatility such as 2004 to 2007, and 2013 to mid-2015, but these are inevitably followed by volatility super-spikes.

During these super-spikes the sellers of volatility are crushed, sometimes to the point of bankruptcy because they can’t cover their bets.

The period from mid-2015 to late 2016 saw some brief volatility spikes associated with the Chinese devaluation (August and December 2015), Brexit (June 23, 2016) and the election of Donald Trump (Nov. 8, 2016). But, none of these spikes reached the super-spike levels of 2008 – 2012.

In short, we have been on a volatility holiday. Volatility is historically low and has remained so for an unusually long period of time. The sellers of volatility have been collecting “steady income,” yet this is really just a winning streak at the volatility casino.

I expect the wheel of fortune to turn and for luck to run out for the sellers.

Here are the key volatility drivers we should be most concerned about:

The North Korean nuclear crisis is simply not going away. In fact, it seems to be getting worse. Intelligence indicates that North Korea successfully tested a hydrogen bomb in September. This is a major development.

An atomic weapon has to hit the target to destroy it. A hydrogen bomb just has to come close. This means than North Korea can pose an existential threat to U.S. cities even if its missile guidance systems are not quite perfected. Close is good enough.

A hydrogen bomb also gives North Korea the ability to unleash an electromagnetic pulse (EMP). In this scenario, the hydrogen bomb does not even strike the earth; it is detonated near the edge of space. The resulting electromagnetic wave from the release of energy could knock out the entire U.S. power grid.

Trump will not allow that to happen, and you can expect a U.S. attack, maybe early next year.

Another ticking time bomb for a volatility spike is Washington, DC dysfunction, and the potential for a government shutdown in December…

Analysts who warn about government shutdowns are often viewed as the boy who cried wolf. We’ve had a few government shutdowns in recent years, most recently in 2013, and two in the 1990s.

These were considered true government shutdowns in the sense that Congress did not authorize spending for any agency, and all “non-essential” government employees were put on furlough. (Critical functions such as military, TSA, postal service and air traffic control continue regardless of any shutdown).

These shutdowns don’t last long. They are usually for one political party or the other to make its point about spending priorities, and are soon compromised in the form of higher spending and a return to business as usual.

Government shutdowns because of lack of spending authority are different from government shutdowns due to lack of borrowing authority and the Treasury’s inability to pay its bills, or hitting the so-called “debt ceiling.”

We had a debt ceiling shutdown in 2011. Those are far more dangerous to markets because they call into question the Treasury’s ability to pay the national debt. We’ve had two near shutdowns this year; one in March, and again at the end of September. Both times Congress passed a last minute “continuing resolution” or CR that keeps government funding at current levels and keeps the doors open until a final budget can be worked out.

The current CR expires on December 8.

This time the odds are high that the government actually will shut down. Why should investors be any more concerned about this shutdown than the one in 2013 or the near misses earlier this year?

There are several causes for concern.

The first is that there is less room for compromise. The White House wants funding for the Wall with Mexico. Many Republican members of Congress want to defund Planned Parenthood. The Democrats will not vote for the Wall or to defund Planned Parenthood, but do want more funding for Obamacare.

There is no middle ground on any of these issues so the chance of a long shutdown is quite high.

The second reason is that this shutdown comes at a time when the U.S. in facing an increased risk of war with North Korea, and Congress has many other tasks on its plate including tax reform, confirmation of a new Fed Chairman, the “Dreamers” legislation, and more. Political dysfunction in Washington can easily spill over into markets.

This time the wolf may be real.

In short, the catalysts for a volatility spike are all in place. We could even get a record super-spike in volatility if several of these catalysts converge.

The “risk on / risk off” dynamic that has dominated most markets since 2013 is coming to an end. From now on it may just be “risk off” without much relief. The illusion of low volatility, ample liquidity, and ever rising stock prices is over.

It has been nine years since the last financial panic so a new one tomorrow should come as no surprise.

The safe havens will be the euro, cash, gold and low-debt emerging markets such as Russia. The areas to avoid are U.S. stocks, China, South Korea and heavily indebted emerging markets.

It may not look like it now, but it could be a volatile and bumpy ride ahead.

Trump Asks That $8 Billion Harvey "Down Payment" Be Added To Debt-Ceiling Bill

Shortly after President Trump backed away from his demand that $1.6 billion in funding for his border wall be included in a continuing-resolution bill to avert a government shutdown, the White House late Friday sent a request for $8 billion in emergency funding for the Hurricane Harvey cleanup effort, and asked that the money be tied to a bill to raise the US debt-ceiling limit. Trump’s request that the two legislative priorities be combined in one bill likely won’t go over well among Congressional Republicans, according to Bloomberg.

Rep. Mark Meadows of North Carolina, the leader of the House Freedom Caucus and perhaps Trump’s most intransigent political adversary, urged lawmakers on Thursday not to bundle the two legislative priorities. In a tweet, Meadows said it’d be “inappropriate” and “would send the wrong message” to use Harvey funds as leverage to force conservatives to vote for a debt-ceiling increase.

The aid money will be needed to shore up the nearly bankrupt FEMA’s finances before some 450,000 Texans file requests for aid. The rising toll of flood-related property damage is expected to quickly deplete the $10 billion left in the coffers of the National Flood Insurance Program.

Using #Harvey relief spending to pass a separate, unrelated bill would be inappropriate and send the wrong message https://t.co/DwHxp6IphB

— Mark Meadows (@RepMarkMeadows) August 31, 2017

Here’s Bloomberg:

“In a letter to House Speaker Paul Ryan requesting the storm aid, Budget Director Mick Mulvaney stops short of explicitly asking for the two to be linked. But the letter makes clear that the emergency spending will accelerate the timetable for raising the limit and conveys the idea that failure to pay obligations could imperil essential government services.

The White House disaster aid request includes $7.4 billion for the Federal Emergency Management Agency and $450 million for the Small Business Administration. The request is intended primarily to cover funding demands through the end of the federal fiscal year on Sept. 30.”

The administration intends to ask Congress to allow the aid to be disbursed in one lump sum, rather than parceling out in monthly installments.

“The White House will ask Congress to provide FEMA with $6.7 billion in that legislation, and provide the full funding upfront, rather than pro-rating the appropriation out over the entire fiscal year, an administration official said. That request, if adopted by lawmakers in a vote likely to come at the end of the month, would provide FEMA with additional flexibility to fund Harvey relief efforts in the new fiscal year.”

Republicans are expected to vote on disaster relief next week after they return from summer recess. Congress is already facing a grueling legislative calendar in September with only 12 working days to pass a continuing resolution, disaster relief, a debt-ceiling increase and, potentially, their effort to repeal and replace Obamacare after the Senate Parliamentarian informed party leaders that the provisions allowing them to pass their health-care bill with a simple majority will expire at the end of the month.

“The administration’s move will test the willingness of Republicans in Congress to link the two must-pass pieces of legislation. House GOP leaders plan to vote next week on Trump’s request in initial disaster relief funding but they don’t plan to include a U.S. debt-limit increase in the legislation, two GOP congressional aides said before Mulvaney’s letter was sent.

"The president visited Texas on August 29, 2017 to reassure the people of Texas that the Federal Government would help them rebuild from the catastrophic flooding and damage to affected communities," Mulvaney said in the letter. "This request is a down-payment on the President’s commitment to help affected States recover from the storm, and future requests will address longer-term rebuilding needs."

According to Bloomberg, citing unnamed Congressional aides, the Senate might be more willing to combine both measures in a bill, and the House, bizarrely, might be more willing to pass a bundled bill if it makes it through the Senate first. Despite the reported rift between Trump and Senate Majority Leader Mitch McConnell, the Kentucky Republican has promised to cooperate with the president. He hasn’t said whether he’d prefer to combine, or separate, Harvey funding and the debt-ceiling increase.

“‘Working closely with the President and the House of Representatives, the Senate stands ready to act quickly to provide this much-needed assistance to those impacted communities, and support first responders and volunteers,’ he said.”

House Speaker Paul Ryan has also been conspicuously silent about how the House intends to pass Harvey relief…

As families & communities begin long recovery from Hurricane Harvey, House will act quickly on @POTUS request for emergency relief funding.

— Paul Ryan (@SpeakerRyan) September 2, 2017

…though he recently told a Wisconsin newspaper that Congress “will not default” on its debts.

“Ryan told the Milwaukee Journal Sentinel, though, that Congress has until October to act on the debt limit.

‘We will not default,’ the Wisconsin newspaper quoted Ryan as saying. ‘We’ve got a lot of options on our plate. We’re going to assess those options. We have until October to figure that one out.’”

We probably won’t have a clear picture of the combined bill’s chances. For what it’s worth, Goldman is optimistic that a compromise can be reached. It recently lowered its odds of a government shutdown to 15%, down from 50% last week.

Goldman: the probability of a government shutdown has declined further from our prior assessment of 35% and now put it at around 15%.

— zerohedge (@zerohedge) September 1, 2017

Let"s hope, for the disaster victims" sake, that the squid is right.

It's Can-Kicking Time Again In The Imperial City

Authored by David Stockman via The Daily Reckoning,

You have to hand it to the Donald. He speaks his mind. This week he dropped an unwelcome stink bomb on Capitol Hill during his Phoenix rant Tuesday night. If Mexico won’t pay for my wall, he seemed to say, than Congress will—-even if I have to shutdown the Imperial City to extract the first $1.6 billion of seed money:

“We’re going to get our wall,” Mr. Trump said at a rally in Phoenix. “If we have to close down our government, we’re building that wall.”

The Mexican Wall waste an estimated $20 billion needed to complete, and would place ICE agents at the border handing out guest worker papers to anyone who comes across looking for a job. That would mean more domestic production and tax revenue, and a tad less addition to the crushing national debt that Washington is handing generations to come.

It didn’t take long for Washington’s permanent political class to say “no dice” to the shutdown idea. It seems Speaker Paul Ryan has been domiciled in the Imperial City since he was 21 years old and makes no bones about his priorities.

“I don’t think anyone’s interested in having a shutdown,” House Speaker Paul Ryan said at a stop at an Intel Corp. facility in Oregon on Wednesday…….

Mr.. Ryan said he expected lawmakers would need to pass a short-term spending bill in September to give them more time to work out a broader budget agreement later this year.

What has the GOP Congress been doing the last nine months that it hasn’t enacted into law a single one of the 12 annual appropriations bills? The same bills that would provide upwards of $1.1 trillion to run the Pentagon and the domestic agencies.

The answer is simple. They’ve been deliberately burning up the clock in order to force spending measures through as emergency continuing resolutions (CRs) or 11th hour compromises to keep the government open. This has been going on for years.  It is the very reason Washington now stands on the edge of raising the national debt ceiling above $20 trillion.

So we’ve officially entered the kick-the-can season. You can count on Paul Ryan to spin and misdirect in order to obfuscate what’s actually going on. The House Speaker is about to capitulate again to the nation’s fiscal doomsday machine. Expect clever maneuvers designed to hide the truth through yet another election cycle.

That’s exactly what Ryan did back during the 2013 shutdown crisiswhen he negotiated a sell-out deal with ultra-liberal Dem Senator Murray to keep the government open through the 2014 election.

In that case, he agreed with Sen. Murray to bust the sequesters caps by $64 billion over FY2014-2015.

Per the typical routine, Ryan got $32 billionon top of the $1.01 trillion already slated to be wasted by the Pentagon during that two year period, while Murray got $32 billion more (a 3.5% increase ) to sprinkle across a myriad of domestic social programs. At the end, all parties were praised by the beltway lobbies.

Likewise, Ryan’s first act as Speaker after succeeding John Boehner following the shutdown crisis of 2015was to pass the Boehner-Obama deal that suspended the national debt limit and empowered the Obama Treasury to borrow at will.

That it did!

As of October 1, 2015, the net debt of the US was $17.66 trillion. After the Ryan-enacted debt limit suspension expired on March 15, 2017, the net debt soared to $19.82 trillion.

Paul Ryan and Continuing Resolutions in the Imperial City

This time, Speaker Ryan is going to need to deploy his best tricks to avoid a giant fiscal mishap. That’s because the White House is occupied by the Great Disrupter. By the looks of Trump’s Twitter account he’s still capable of unleashing the kind of impulsive curve ball that the Imperial City simply cannot anticipate.

Having already complicated the appropriations and CR, the Donald piled on more by suggesting GOP leadership had already screwed up raising the debt ceiling during the few days available when Congress returns from August recess.

Opined the Donald,

I requested that Mitch M & Paul R tie the Debt Ceiling legislation into the popular V.A. Bill (which just passed) for easy approval. They……didn’t do it so now we have a big deal with Dems holding them up (as usual) on Debt Ceiling approval. Could have been so easy—–now a mess!

Here’s the thing. Trump is 70 years old and has spent just eight months in the Imperial City, or about 1.0%of his life. Ryan and McConnell are collectively 122years old and have been playing their trades in the Great Swamp for 82collective years, or two-thirdsof their lives.

The rank and file Republicans on Capitol Hill desperately fear being blamed for a shutdown. They have bound themselves as hostage to both the Fiscal Doomsday machine and the main street media’s need to safeguard Uncle Sam’s credit at all costs.

CNN talking boxes would have a field day excoriating the GOP for shutting down the government. Now that the GOP allegedly controls the White House and both chambers of Congress the situation is even more muddled. Thus, as one member of the Freedom Caucus opined to the Wall Street Journal,

“A government shutdown hurts Republicans—it’s the last thing I want,” said Rep. Trent Franks (R., Ariz.), a member of the House Freedom Caucus who was at Mr. Trump’s rally Tuesday. “It is a political liability of profound significance to us.”

Many GOP lawmakers worry a shutdown or a failure to raise the government’s borrowing limit—another deadline they are facing this fall—could harm their chances of retaining the House majority in next year’s midterm elections. Treasury officials have said Congress must raise the government’s borrowing limit at some point near the end of September.

The real aim is herding legislators into the Christmas holiday. In that circumstance, as has been proven over and over in the past, not even the most resolute hawks have been able to stand by their convictions. The mantra always becomes “on to next year for real reform!”

Goldman Sachs, Debt Ceilings and Can Kicking

But perhaps this time it will be even worse. The Goldman Sachs Regency in the White House would readily sign up for the skinny bill and three-month punt. They are flat-out desperate to keep the casino at bay and the stock average from plunging.

Assuming that the Donald doesn’t blow-up the proceedings on a skinny bill, the maneuvering for a December deadline would be where the rubber could finally meet the road. That’s because there would need to be at least a $1.5 trillion debtceiling increase just to make it to December 2018 under current tax and spending policy.

The Treasury will need to borrow $500 billionor more to replenish its depleted cash balances and to pay back the funds which allowed it to pay the bills since March 15. The Treasury will be running upwards of an $800 billionannualized cash deficit between now and December 2018.

Even with a $1.5 trillion interim debt ceiling increase, there still wouldn’t be room for a single dime of tax cuts on top of the red ink that is already baked in. When it comes to Wall Street’s hope that Congress will pass a tax bill before the end of the year, or the next election – fuggedaboutit!

There’s no way to get a big enough debt ceiling increase to accommodate the current structural deficits and the Trump Stimulus, without major help from the Democrats.

The can kicking season is once again here, and this one will be like no other.

Compass Point: "Odds Of A Government Shutdown Are Now Dramatically Higher"

Over the weekend, Morgan Stanley reminded its clients that the biggest threat facing markets over the coming weeks is the “three-headed policy monster” inside Washington: raising the debt ceiling, passing a budget and embarking on tax reform. As MS cross-asset strategist Andrew Sheets noted, "none are easy, but we see the debt ceiling as the most immediate test."

He then cautioned that while the most likely outcome is that, after some tension, the debt ceiling gets raised "we don’t think it will be easy, or smooth, and it may require some form of market pressure to get different sides to fall in line. I’ve spoken to investors who are comforted by FOMC transcripts from 2011 that discussed prioritization of debt payments in order to avoid default. I am not. First, I worry that this reduces the urgency of what remains a serious issue. Second, this prioritization would require delaying payments to programmes like Social Security and Medicare, with real human and economic cost. And third, while the mechanics of this prioritisation may work, it is untested in a live environment."

As reported earlier, the market"s concerns about a potential debt ceiling crisis, so far mostly contained, have once again started to bubble to the surface, with the Oct. 5 T-Bill rate rising to the highest level since August 1st, suggesting that bond traders see rising odds of a "worst case outcome" and partially answering our question from Monday whether "Markets Are Sleepwalking Into A Debt Ceiling Crisis: Mnuchin Issues Another Warning."

Additionally, the yield spread between the Sept 28 and Oct 5 Bills is now the widest on record:

The blowout has come after the latest warning by Treasury Secretary Steven Mnuchin, who on Monday said that "we need to raise the debt limit and it’s my strong preference is that there’s a clean raise of the debt limit."

However, as of this morning, it"s not just the debt ceiling that traders have to worry about, because as discussed overnight, a new potential problem emerged last night when Trump told a Phoenix rally that he is commited to securing funds for a border wall, even if it results in a government shutdown.

While last night"s rally audience loved the threat, Democrats promptly blasted it: on Wednesday, Chuck Schumer ripped Trump for threatening to shutdown the government: “If the President pursues this path, against the wishes of both Republicans and Democrats, as well as the majority of the American people, he will be heading towards a government shutdown which nobody will like and which won’t accomplish anything," Schumer said on Wednesday. Including funding for a physical wall is considered a non-starter for Democrats, whose votes will be needed to get a government funding bill through the Senate.

We doubt a warning from the Senate Minority Leader, or any other Democrat or Republican for that matter, will have much of an impact on Trump"s decision-making if he has indeed set his mind on procuring border wall funding. Which is also why in a note from Compass Point released this morning, strategists Isaac Boltansky and Lukas Davaz warn that not only is the risk of a government shutdown bigger than the debt limit, but that Trump"s commitment to securing funds for a border wall, together with Trump"s "injurious relationship" with GOP leaders - best demonstrated by last night"s NYT bombshell article laying out the open war between Trump and Senate Majority Leader Mitch McConnell - “dramatically raises the spectre of a shutdown in October.” Here are the highlights of their note, courtesy of Bloomberg:

• The prospect of a govt shutdown “still poses a potentially serious downside risk for investors,” even as “our firm belief that the debt ceiling will be lifted removes a profound political risk from the landscape”


• Trump’s commitment to securing funds for a border wall “dramatically raises the spectre of a shutdown in October” and his “injurious relationship” with Congressional Republican leadership “further complicates the underlying calculus”

Compass Point adds that four factors increase the potential for an equity market sell-off as government shutdown risks intensify:

• Further delays confirmations, which would affect Trump’s deregulatory agenda;


• Delivers a “psychological blow” to markets, serving as a “concrete symbol” of Washington’s inability to govern;


• Delays legislative progress on tax reform;


• Alters Fed’s policy normalization trajectory

In summary, while Compass Point says that lawmakers will promptly raise the debt ceiling in mid-September, or less than a month from now - something which Morgan Stanley and others find hard to believe - a government shutdown in October suddenly all too likely.

Then, shortly after the note was released, rating agency Fitch also chimed in and warned that if the U.S. debt limit is not raised in a timely manner, it would review the U.S. sovereign rating, with potentially negative implications. In other words, Fitch is warning that a repeat of August 2011 - when S&P infamously downgraded the US to AA+ after the failure to raise the debt ceiling resulted in a brief technica default0 is now on the table. The silver lining: Fitch said that a government shutdown following a debt ceiling increase, such as the one envisioned by Compass Point, would not direct affect on U.S. AAA rating.

Finally, for those who are still on the fence about the likelihood of a shutdown and are otherwise unhedged, one month ago Bank of America put together a "costless" spread collar trade, should volatility surge in the coming weeks as a debt ceiling/government funding deal emerges as unlikely. Here again is how to make money should the US government shut down in just over a month.

Trade idea: VIX Oct 12/14/19 call spread collar for zero-cost upfront

We are comfortable selling VIX puts to leverage a likely floor in volatility, particularly ahead of the debt ceiling, and using the premium collected to the cheapen the cost of portfolio protection. For example, investors may consider selling the VIX Oct 12 put vs. the 14/19 call spread, indicatively zero-cost upfront with a net delta of +54 (Oct fut ref 13.35).

The trade leverages the facts that (i) VIX 3M ATMf implied volatility, while low, is not necessarily cheap compared to the level of the VIX 3M future (Chart 14), and (ii) VIX 3M call skew is currently very steep, in the 92nd percentile since Sep-09 (Chart 15).

More critically, while VIX call spread collars have been challenged by recent sub-11 VIX settlement values, they can be successful, low-cost hedges when there are defined macro catalysts on the calendar to provide support to volatility, as seen from the US election and more recently the first round of the French election.

Lastly, we are comfortable capping upside via the call spread as the VIX 1M and 2M futures have not closed above 20 since Brexit over one year ago.

Chris Christie Signs Budget Bill, Ending New Jersey Government Shutdown

After a three day state of emergency and government shutdown, on Tuesday morning New Jersey Gov. Chris Christie signed a compromise budget bill ending the state shutdown that became an embarrassment for the outgoing governor when he was photographed lounging on a beach that had been closed to the public for the holiday weekend. According to Reuters, Christie ended the state shutdown by signing a $34.7 billion budget measure that included a controversial provision reshaping the state"s largest health insurer, Horizon Blue Cross Blue Shield of New Jersey, which covers 3.8  million people in the state.

I’m pleased the Legislature has reached an agreement which fulfills their obligation of delivering a budget. https://t.co/O0mowBASN3

— Governor Christie (@GovChristie) July 4, 2017

Christie said all state parks and beaches would be open on Tuesday for the Fourth of July holiday and state offices would be open as usual on Wednesday, and added that he was happy a resolution had been reached on the budget impasse, but saddened it came three days late.

Today I signed my final balanced budget, delivering 2 full terms of unprecedented pension stability, fiscal responsibility & tax relief. pic.twitter.com/3oUmzENLNR

— Governor Christie (@GovChristie) July 4, 2017

"This bill is a long overdue significant reform that will have a lasting impact on New Jersey residents," he said before signing it into law.

Separately, NJ State Senate President Steve Sweeney told a news conference: "None of this was easy." Assembly Speaker Vincent Prieto also chimed in, saying the agreement to end the partial government shutdown was reached after long talks in "crisis" mode on Monday with Horizon and state legislators.

As noted yesterday, while Christie was largely a non participant in the bduget standoff, he was ridiculed after NJ.com posted photos of the Republican governor and his family sunbathing on a beach that had been closed to the public over the holiday weekend due to the budget standoff.

In characteristic fashion, Christie downplayed the kerfuffle. "If they had flown that plane over the beach and I was sitting next to a 25-year-old blonde in that beach chair next to me, that"s a story."

While states have mostly recovered since the 2007-2009 recession, their revenue growth has not always kept pace with the national economy.

More than 30,000 state workers who were furloughed on Monday, would get back to their jobs as a result of the new budget.

Elsewhere, just like Jersey, the state of Maine ended also a 3-day government shutdown on Tuesday when Governor Paul LePage signed a budget for the fiscal years 2018 and 2019 following late-night negotiations with legislative leaders, the governor"s office said in a statement. Previously, members of Maine"s State Employees Association rallied outside the State House to demand a budget deal from lawmakers and Republican Governor Paul LePage.

"The Maine state government shutdown is now over. Happy Fourth of July!" LePage said.

"I have signed a budget with no tax increase. I thank the House Republicans for standing strong for the Maine people," he said in a second tweet. Maine state police, parks and offices responsible for collecting revenue had all planned to work through the shutdown, the state"s first since 1991.

While NJ and Maine are back to spending money they don"t have, about 10 U.S. states still do not have budgets for the fiscal year that began on July 1, including Illinois, which is in its third year without an enacted budget.

Earlier today, the Illinois Senate voted to approve the final budget bill passed by the House, however Illinois Governor has vowed he will veto any spending bill, and it was unclear if and how his opinion would be overruled.

Chris Christie Announces New Jersey Government Shutdown, Orders State Of Emergency

Illinois, Maine, Connecticut: the end of the old fiscal year and the failure of numerous states to enter the new one with a budget, means that some of America"s most populous states have seen their local governments grind to a halt overnight until some spending agreement is reached. Now we can also add New Jersey to this list.

On Saturday morning, New Jersey Gov. Chris Christie declared a state of emergency in the state, and announced a partial state government shutdown as New Jersey become the latest state to enter the new fiscal year without an approved budget after the Republican governor and the Democrat-led Legislature failed to reach an agreement by the deadline at midnight Friday, CBS New York reports.

WATCH: New Jersey Gov. Chris Christie announces state government shutdown amid budget impasse https://t.co/T5uqoA85rO pic.twitter.com/OHkOHXEl5P

— CBS News (@CBSNews) July 1, 2017

In a news conference Saturday morning, Christie blamed Democratic State Assembly Speaker Vincent Prieto for causing the shutdown. And, just like Illinois and Connecticut, Christie and the Democrat-led Legislature are returning to work in hopes of resolving the state"s first government shutdown since 2006 and the first under Christie, before NJ is downgraded further by the rating agencies.

"If there"s not a resolution to this today, everyone will be back tomorrow," Christie said, calling the shutdown "embarrassing and pointless." He also repeatedly referred to the government closure as "the speaker"s shutdown."  Christie later announced that he would address the full legislature later at the statehouse on Saturday.

Prieto remained steadfast in his opposition, reiterating that he won"t consider the plan as part of the budget process but would consider it once a budget is signed.  Referring to the shutdown as "Gov. Christie"s Hostage Crisis Day One," Prieto said he has made compromises that led to the budget now before the Legislature.

"I am also ready to consider reasonable alternatives that protect ratepayers, but others must come to the table ready to be equally reasonable," Prieto said. "Gov. Christie and the legislators who won"t vote "yes" on the budget are responsible for this unacceptable shutdown. I compromised. I put up a budget bill for a vote. Others now must now do their part and fulfill their responsibilities."

Politics aside, the diplomaitc failure has immediate consequences for Jersey residents: Christie ordered nonessential services to close beginning Saturday. New Jerseyans were feeling the impact as the shutdown took effect, shuttering state parks and disrupting ferry service to Liberty and Ellis islands. Among those affected were a group of Cub Scouts forced to leave a state park campsite and people trying to obtain or renew documents from the state motor vehicle commission, among the agencies closed by the shutdown.

As funds run out elsewhere, it will only get worse.  Police were turning away vehicles and bicyclists at Island Beach state park in Ocean County.

BREAKING: NJ Park cops turn away dozens at Island Beach State Park in Govt #Shutdown @NBCNewYork @JSHurricaneNews @tedgreenbergNBC pic.twitter.com/NplmGahc4l

— Brian Thompson (@brian4NY) July 1, 2017

A sign posted at the park entrance featured a photo of Prieto and the phone number of his district office in Secaucus, along with the caption: "This facility is CLOSED because of this man."

When asked about the sign, Christie spokesman Jeremy Rosen said the governor wanted to make sure people knew why the site was shuttered.  "Speaker Prieto singlehandedly closed state government," Rosen said, adding that the governor wanted to make sure families "knew that the facilities were closed and who is responsible."

Not all things will be affected: remaining open under the shutdown will be New Jersey Transit, state prisons, the state police, state hospitals and treatment centers as well as casinos, race tracks and the lottery. 

A major point of disagreement is the ongoing stalemate between Christie and lawmakers over whether to include legislation affecting the state"s largest health insurer into the state budget.

Christie and Senate President Steve Sweeney agree on legislation to make over Horizon Blue Cross Blue Shield, including allowing the state insurance commissioner to determine a range for the company"s surplus that if exceeded must be put to use benefiting the public and policyholders.  But Prieto opposes the plan, saying that the legislation could lead to rate hikes on the insurer"s 3.8 million subscribers and that the legislation is separate from the budget.  Prieto has said he will leave open a vote on the $34.7 billion budget that remains deadlocked 26-25, with 24 abstentions, until those 24 abstentions change their mind.

Real-time view of NJ government shutdown. Green/red indicates votes either way on budget. Yellow lights the culprits, says Assembly speaker pic.twitter.com/lRpzAPGcyH

— Bob Jordan (@bobjordanAPP) July 1, 2017

Democratic Assemblyman Vince Mazzeo, of Northfield, was among those abstaining. He reasoned that if the governor did not get the Horizon bill, then nearly $150 million in school funding -- $9.6 million of which would go to his district -- would be line-item vetoed out of the budget.   And indeed, Christie said Friday during a news conference that he would slash the Democratic spending priorities if he did not get the Horizon bill as part of a package deal on the budget.  "You want me to wave a magic wand to get a budget?" Christie said. "I can"t get a budget to my desk. Only the Senate and Assembly can get the budget to my desk."

But where things may get nasty quick, is that Christie said public workers should not expect any back pay. "Yeah, don"t count on it." Christie said of furlough pay. "That was Jon "I"ll Fight For a Good Contract For You" Corzine. I ain"t him."

Christie says no furlough pay now: "Yeah, don"t count on it. That was Jon "I"ll Fight For a Good Contract For You" Corzine. I ain"t him."

— Michael Symons (@MichaelSymons_) July 1, 2017

Meanwhile, the fingerpointing has begun, including Democrats pointing at other Democrats.

"It seems like he"s just being stubborn," Mazzeo said of Prieto. "With all due respect to the speaker, then there should be some type of negotiations." But Prieto said it"s lawmakers - fellow Democrats - like Mazzeo who are to blame for the shutdown. He said he is willing to discuss the Horizon legislation but after the budget is resolved.

Christie has balked at the proposal because he says lawmakers plan to leave town to campaign for re-election and he will be a lame duck.  According to CBS, all 120 lawmakers face voters this year.

Finally, putting the sheer chaos of it all in context, Christie who is term-limited and is expected to be out of office by January, has his family staying for the holiday weekend in a state-owned house at Island Beach State Park. The park is closed because of the shutdown.

Maine To Begin Shutdown After Gov. LePage Says He Won't Sign Budget Bill

After Maine Gov. Paul LePage delivered an ultimatum to state lawmakers, promising to provoke a government shutdown should the state"s legislature hand him a budget that includes a tax increase, it appears the governor intends to keep his word.

LePage told reporters at the state capital that he won"t sign anything Friday, ensuring that a shutdown will begin at midnight, because the current budget proposalwhich was endorsed late Thursday by a special panel of lawmakers but has not yet been approved by the state legislature, includes a 1.5% lodging tax increase.

According to the Bangor Daily News, the budget package currently under consideration would raise the lodging tax from 9% to 10.5%. The budget does, however, include a 3% cut to an education surtax on individuals earning more than $200,000. LePage has also taken issue with the size of the $7.1 billion budget.

To be sure, it’s not entirely certain that the budget will even make it to the governor’s desk before the day is over. That’s because LePage has asked the state’s House Republicans to oppose the deal, which was negotiated by Senate President Mike Thibodeau, R-Winterport, and House Speaker Sara Gideon, D-Freeport.

LePage has embraced brash rhetoric during the budget fight, accusing lawmakers of “trying to put a gun to the governor’s head."

“This budget they have has no prayer, and if they’re hell-bent on bringing this budget down, we will shut down at midnight tonight and we will talk to them in 10 days,” LePage said.

LePage’s comments came hours before the House and Senate were due to vote on the compromise spending plan.

Gideon, the democratic opposition leader, said lawmakers should focus on ginning up the two-thirds support that a deal would need. The governor can only legally sit on the budget for ten days before either vetoing or signing it. Once it has been vetoed, the legislature could override the governor with a two-thirds majority vote.

“If we do not do that and if the governor then does not do his job by either signing the budget or returning it to us immediately with his veto then we will be damaging the lives of too many people in this state,” she said.

Some Democrats have expressed a desire to work with the governor in eliminating the tax hike at issue in the bill.

“Senate Minority Leader Troy Jackson, D-Allagash, said during a hastily organized news conference after the governor’s comments that he will personally introduce a bill to eliminate the proposed lodging tax increase if that would spur LePage and Republicans to support the budget bill, though Gideon said she wouldn’t support any changes late in the process.

“If the governor has objections to the lodging tax, that’s fine,” Jackson said. “I will personally sponsor any bill he puts in that eliminates the increase in the lodging tax.”

Under a shutdown, Maine would have no authority to pay workers, meaning the state’s roughly 12,000 employees will either work or stay home without pay, LePage announced Thursday that state law enforcement, state parks, psychiatric hospitals, prisons and ferries will remain operational, but that was only a partial plan. During the state’s last shutdown, in 1991, 2,000 employees were called into work at the beginning of the shutdown.

The shutdown, though brief, could have a major impact on the state’s economy, according to BDN.

“Workers represented by the Maine State Employees Association will lose wages generating $2.5 million in daily economic impact, according to an analysis from the liberal Maine Center for Economic Policy, with $944,000 in Kennebec County alone.”

Uncertainty surrounding whether state workers will be paid next week inspired a wave of protests at the capitol.

Some of those union members were at the State House on Friday, including Kip Mitchell, 53, a Maine Department of Transportation employee who said he’s the only wage earner in a family of four who said “the uncertainty is scary.”

Jonathan French, 38, of Hallowell, a civil engineer in the same department, said he had worries besides his job, since his young son gets services through the Maine Department of Education’s Child Development Services program.

“We’re citizens, too, so we’re going to be out of work, but we’re also going to experience all the other effects of the shutdown … ,” he said. “So, it’s kind of a double-whammy for us.”

Two other states, Connecticut and Illinois, are struggling to pass budgets on Friday. Connecticut, which has seen its debt downgraded by all three of the major ratings agencies in recent months, is trying to winnow a $5 billion budget deficit that’s driven largely by overly generous benefits to state employees. Connecticut Gov. Dannel Malloy signed an executive order Friday afternoon to take control of state spending after the legislature was unable to reach a deal on the bienniel budget.

Illinois, which has been operating without a budget for two years, could see its debt rating downgraded to junk territory if it fails to pass a budget. As the situation in Illinois appears increasingly uncertain, its house speaker has said he will ask the credit agencies to defer action based on progress being made toward an accord.

Right. Good luck.

"You Want To Play Chicken? Let's Play Chicken" Maine Governor Threatens Shutdown Over Proposed Tax Hike

Connecticut isn’t the only state in New England that’s facing a budget showdown today. As Reuters reports, Maine is bracing for a possible partial government shutdown on Friday – what would be the first in the state since 1991 - as Republican Governor Paul LePage has warned he will reject any budget deal that does not cut income taxes.

LePage, a second-term Republican who faced national scrutiny and calls to resign earlier this year after making an allegedly racist comment about out-of-state drug dealers worsening the heroin epidemic in Maine, said he would declare a state of civil emergency if a budget is not reached by midnight, which would keep state police, prisons, parks and tax collection services but close most other aspects of state government, according to Reuters.

"I will tell you this: If they put a tax increase, ready for a shutdown. End of story," LePage said in a Thursday interview on Maine"s WGAN radio. "They"re playing chicken at 100 miles per hour and I"m telling you something, you want to play chicken, let"s play chicken."

The conflict at the center of the budget showdown is the issue of funding the state’s schools, as Reuters explains.

“Legislators are negotiating a roughly $7 billion two-year budget, with the main sticking point being how to fully fund state schools. Voters in November passed a measure imposing a 3 percent income tax on state residents who earn more than $200,000 a year, a measure the governor and statehouse Republicans object to.

The Democratic Speaker of the state House of Representatives, Sara Gideon, has blasted the threat of a shutdown, saying earlier this week, "We must find a path forward and close this budget."

Maine state law gives the governor 10 days to respond to any budget passed by the legislator. LePage warned on Thursday he planned to wait that long before vetoing any budget that raised taxes. Most of the government would be shut during that time.”

Delays this year in negotiations leave the state, with a heavily tourist-dependent economy, facing the prospect of a partial government shutdown at the start of the long July 4 holiday weekend.”

Concerned about the potential impact of a shutdown, a local advocacy group is preemptively suing the state in federal court, seeking an order that would ensure that public assistance payments continue uninterrupted to the 450,000 people in the state, about one in three residents, who receive them.

To be sure, the stakes in Maine’s budget battle aren’t nearly as high as Connecticut’s. The nutmeg state has yet to pass a fiscal 2018 budget, and the deadline is Friday. Connecticut has the distinction of the third-worst ratings in the country, only behind Illinois and New Jersey after S&P, Moody"s and Fitch all downgraded the state last month in what officials described as a "call to action" for state leaders.

“We’ve been downgraded by everybody in the last six months, and in the last year two or three times,” Senate Republican President Len Fasano said cited by Fox news. “If we don’t pass a budget, I think we will see a further downward spiral.”

Connecticut is currently operating with a $5 billion budget deficit, and according to an analysis by Pew, the state only has $240 million in its "rainy day fund"; just five states have a smaller cushion. Much of the financial troubles are tied to the state’s pension system, which two-term Democratic Gov. Daniel Malloy’s office is seeking to address with a new plan to save the state $24 billion in “coming years.” One solution offered by Malloy is to require new state employees to be covered under a new hybrid pension system. The agreement, which Malloy’s office made with the state union, is tentative and awaiting legislative approval. Connecticut and Maine aren"t alone; Illinois also faces a Friday budget deadline that, if not met, could result in ratings agencies downgrading the state - which is struggling under the weight of unfunded public employee pensions - to junk status, virtually guaranteeing a debt-fueled death spiral that will likely lead to bankruptcy.

The showdown comes as Connecticut’s already narrow tax base has seen some major defections recently as corporations and wealthy hedge funds decamp for states like Florida, which offer lower tax rates, or cities like Boston and New York, which offer a stronger talent pool. Yesterday, we reported that Aetna, the insurance giant founded in Hartford where it has been for the past 164 years, announced it would move its headquarters to New York City despite intensive lobbying efforts by Connecticut officials. That move followed a departure by GE of its Fairfield HQ of 40 years.