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Five months into 2023, investors are still wondering the Federal Reserve’s stance on how much it will hike interest rates to combat persistent inflation. In early May we witnessed a Fed meeting This resulted in a further increase of 25 percentage points. The key interest rate for overnight money has thus reached its highest level in over 16 years.
The question “Will they keep raising interest rates in the coming months?” The question is paramount as the US economy has rallied despite an aggressive Federal Reserve committed to fighting inflation, which is still well above its 2- Percent target is proven resilient. In recent comments from Chairman Jerome Powell, he hinted that the Federal Reserve is considering not raising interest rates in June, depending on what the economic data show. The next meeting is scheduled for June 14th.
The Fed meeting marked the start of a volatile month as indices fell after the rate hike. Stocks rebounded and the S&P 500 hit its 2023 high as debt ceiling negotiations began. Investors had been looking for any indication that the government would come to an agreement to raise the country’s debt ceiling and avoid a default.
While the debt ceiling made headlines during the month, other notable news items included a rise in job vacancies in April that reversed the previous three-month decline – surprising news as sustained declines would provide an incentive for the Fed to halt raising rates . Consumer spending, the main driver of economic growth, also rose 0.8% in April, showing consumers are resilient and remain willing to spend on things like vehicles, summer travel and concert tickets.
With the debt ceiling now seemingly behind us and the Fed’s next rate decision looming in the not too distant future, let’s look back at the month’s financial market performance:
- S&P 500: +0.25%
- Dow Jones: -3.49%
- NASDAQ: +5.80%
- US 10-year Treasury yield: +0.24%
Our perspective
Our base case remains a recession given the extent of the tightening that has taken place and may continue to take place to bring down inflation.
With this outlook, we assume that the risk for the financial markets is increased and therefore prefer a defensive positioning in the portfolios. We control the controllable factors by putting our processes into action and identifying the companies that can generate strong cash flows in this business cycle and have strong competitive positions in their industries. For the pro-cyclical areas, we continue to build our shopping lists and await a better opportunity to increase our exposure to these areas of the market.
Debate on the debt ceiling
The role of the debt ceiling has been a growing concern in recent months, hitting the front pages as talks intensified ahead of today’s June 1 deadline. Congress needs to raise the debt ceiling to remove enough cash from the market to pay its bills and avoid a default.
Therefore, we assumed that a real default would be essentially impossible. However, that doesn’t mean we couldn’t see a solution that would force the US Treasury to prioritize debt-related payments over other expenses like entitlements or government payrolls.
Nonetheless, the dispute over the debt ceiling was noisy and ended up to the last minute. As we saw in 2011, this can have serious implications for financial markets and we expect volatility could increase as we get closer to the date when we break the debt ceiling. Ultimately, a negotiated settlement is the likely outcome, where we see a temporary increase in the debt ceiling in exchange for a promise to cut spending at some point in the future.
We shared these views in our latest article, 5 Economic Updates and Our Views on Each.
Our view
- business cycle – The economy is late cycle; The Fed is being forced by high and persistent inflation to tighten in an already flagging economy. A US recession is becoming increasingly likely.
- stock market – US stock market weakness has boosted valuations, however stocks are not cheap by longer term historical comparisons; Valuations can be partially explained by the company’s robust profitability, as EBIT margins soared to historic highs in the post-coronavirus years. Increased input costs and weaker demand pose a risk to firms’ ability to sustain this high level of profitability. Returns will be harder to come by and stock picking will become increasingly important.
- bond market – Interest rates have risen significantly from their lows, reflecting changing expectations for inflation, growth and central bank policy; Credit spreads on corporate and municipal bonds have widened, but not enough to make them much more attractive right now.
- Key Issues on the Radar – Inflation: The combination of massive policy stimulus, tight labor markets, constrained supply chains and rising energy costs has meant inflationary forces have broadened and become more entrenched than previously expected. Ukraine-Russia War: An environment of heightened geopolitical risk brings with it a general risk-off environment that is buoyant for the dollar, gold and commodity prices. China’s economy: China has focused on the two key economic issues that have acted as strong headwinds to growth over the past two years; We now have to wait and see how strong and sustainable the recovery in growth will be.
Sources: Wall Street Journal, Bloomberg
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Editor’s note: The summary bullet points for this article were selected by Seeking Alpha editors.
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