Budget games, taxes and Treasuries

Good morning. After two days meeting with Chinese vice-premier He Lifeng, Scott Bessent said “the talks were productive.” He Lifeng called the meetings “constructive” and said that “important consensus” had been reached. Sounds good to us, and we (and the market) are eager to hear more details today. Will we get any? Email us: robert.armstrong@ft.com and aiden.reiter@ft.com.

The budget is a little scary

As the trade war noise quietens down — however slightly — there is more room on front pages for the US budget and deficit. More and more news is emanating from Washington about budget negotiations, unexpected White House proposals, and party divisions over the debt ceiling. The market is taking notice. The cost of a 1-year credit default swap on a 5-year Treasury, or the price required to hedge against a US sovereign default, is rising fast. It is now around the same level as past periods of debt brinkmanship. Chart via Alphaville:

Treasury yields have come down in the past three weeks, but all the work has been done by falling real interest rates (probably signalling lower growth expectations). Most measures of the term premium, the extra yield investors need to hold longer duration, are still high relative to recent history. Investors are not in love with duration risk:

The chances of a near-term default on US sovereign debt are of course very low. What CDS and term premiums are telling you is that the chances of fiscal brinkmanship and general partisan foolishness, with the attendant possibility of a very stupid mistake, are rising. 

Ever since the debt ceiling suspension expired in January, the Treasury has been running down the Treasury General Account, its cash balance at the Fed. At $583bn, we still have some time until the “X date”, or the day the funds run out; the Treasury department says the X date will be some time in August, but that is just an estimate. If we do run out, the US government will resort to “extraordinary measures” to avoid default: the Treasury will pause or redeem various investments, and start dipping its hands into other pots of money, like the exchange stabilisation fund, to stay solvent. Let’s hope we don’t have to stoop that low. 

Meanwhile, Trump seems intent on gutting the Internal Revenue Service, sparking some to worry that tax revenues could come in low this year — bringing us to the X date faster. Inflows from April, when most US citizens pay their income taxes, generally account for 20 per cent of annual revenues. That makes it a good month to gauge the revenue outlook. Thankfully, inflows were strong, says Shai Akabas at the Bipartisan Policy Center:

We have calculated that [the IRS has] collected $900bn during the month of April, which is 9 per cent higher than April of 2024. We have also looked at it on a weekly basis . . . and each week of [January to April] this year saw either the same or higher average daily revenues than during the same period last year.

But we may be slightly below the Congressional Budget Office’s estimates for this year, which forecast the US to collect $245bn more in tax revenues than in fiscal year 2024. According to calculations by the Penn Wharton Budget Model, receipts are slightly behind the level needed to meet the CBO’s forecast. And that is including a jump in customs revenues from higher tariffs and the recent import surge. In the first quarter of 2025, the US raised $22bn in customs revenues, 21 per cent more than in the first quarter of 2024 and 18 per cent more than in the first quarter of 2023. But that is a small sum against the $5.2tn in total tax receipts that CBO expected this year. Also, if we assume those imports were pulled ahead demand, that extra revenue should evaporate in the next few quarters:

In the coming weeks, various estimates will come out about just how long we have until we hit the X date. The estimates are just that, however: inflows are sporadic and choppy, and it is still unclear if the IRS will continue to function well. But investors can take comfort that tax revenues look solid enough for now. 

(Reiter)

Did Greedflation happen at all?

Last summer we wrote three pieces about the concept of greedflation, which we described as

an increase in prices caused by higher corporate profits, as opposed to an increase in prices caused by high input costs which corporations pass on to customers, leaving profits stable. In the pandemic inflationary episode, the charge against corporations was that they used price shocks as a co-ordination mechanism. Under the cover of a general atmosphere of higher prices, corporations pushed prices higher than was required by more expensive commodities, labour, and so on. This padded profits at consumers’ expense.

Now that inflation has been stable for longer, we wanted to take another look. Have the companies that pushed prices particularly aggressively during the 2021-2023 inflationary episode seen a sustained higher level of profit? Or, if they did see a burst of higher profit, have they given it back since? Last year we focused on the food and beverage industry, both because many companies in the industry report their pricing actions and because inflation in food at home consumption was particularly acute in the US: 

And within food, we paid the most attention to the global biscuit and candy maker Mondelez, because among large public companies its pricing was among the most aggressive. Looking at Mondelez’s global revenue broken down into volume/mix and price, two interesting things have happened. Price increases, which had been decelerating, have stopped doing so. And volumes, which were starting to wobble, have got worse: 

Over six years, Mondelez has increased prices by 44 per cent in aggregate, or a bit over 6 per cent a year on average. That accounts for almost all of the roughly 40 per cent aggregate increase in revenues it has seen over the same period.

It is interesting that Mondelez feels it can push prices aggressively even in a much milder global inflation climate (apparently at an acceptable cost in terms of volumes). This cuts against the idea that “greedflation” uses high background inflation as cover for gratuitous price increases, at least in Mondelez’s case. But something we noticed before also remains true: aggressive pricing appears to be doing relatively little to improve margins (note that the sharp fall in margins in the last two quarters seems to be down mostly to high cocoa prices):

To the degree that price increases improved Mondelez’s profitability, it did so by increasing revenues and keeping margins more or less steady (barring wild cocoa prices). As you can see, after some delay, those higher prices did filter through to operating cash flow, which has hit a plateau about a fifth higher than pre-pandemic:

But here’s the thing: the CPI price index is also up about a fifth since the pandemic. So Mondelez took all that pricing to keep profits in roughly the same place in real terms. That’s a simplification of course; Mondelez is a global company so its profits have to be considered in terms of global, not US, inflation. And more importantly than that, there is always a lot more going on at a big company than just volumes and pricing. Yet, the basic point stands. At Mondelez, one of the most aggressive price takers in an industry that saw a lot of inflation, it is hard to find any evidence of greedflation at all.

Is there any evidence of greedflation anywhere else? Or can we treat the concept as a historical oddity and move on?

Correction

In Friday’s letter, we incorrectly stated that Taiwan has a massive trade deficit with the US. We got our wording jumbled — Taiwan runs a massive trade surplus, not deficit, with the US. Our apologies.

One Good Read

Brooks on Murakami.

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