Five months into 2023 and investors are still questioning the Federal Reserve’s position on how high they will bring interest rates to fight persistent inflation. At the beginning of May, we saw a Fed meeting that brought yet another 25-percentage point hike with it. This brings the benchmark federal-funds rate to its highest level in over 16 years.
The “Will they continue to raise rates in the coming months?” question is top of mind as the U.S. economy has shown resilience despite an aggressive Federal Reserve committed to fighting inflation that is still well above their 2% target. In Chairman Jerome Powell’s latest remarks, he suggested that the Federal Reserve is considering skipping a rate hike in June depending on what the economic data is showing. The next meeting is scheduled for June 14th.
The Fed meeting was the beginning of a volatile month as indices fell after the hike. Stocks bounced back, with the S&P 500 hitting a high for 2023 as debt-ceiling talks began. Investors had been looking for any indication that the government would come to an agreement to raise the country’s debt limit and avoid defaulting on its debt.
While the debt ceiling took over headlines throughout the month, other notable stories included an increase in job openings in April that washed away the previous three-month decline – this was surprising news as continued declines would be an incentive for the Fed to cease raising rates. Consumer spending, the key driver of economic growth, also ticked up 0.8% in April, highlighting that consumers are resilient and are still willing to spend on things such as vehicles, summer travel, and concert tickets.
With the debt ceiling now appearing to be behind us, and the Fed’s next rate decision in the not-so-distant future, we can look back on financial market performance for the month:
- S&P 500: +0.25%
- Dow Jones: -3.49%
- NASDAQ: +5.80%
- 10-year US Treasury yield: +0.22%
A recession continues to be our base case given the extent of tightening that’s happened, and may continue occurring, to bring inflation down.
With that outlook, our view is that the risk to financial markets is elevated and therefore favor a defensive positioning in portfolios. We are controlling the controllables by putting our processes to work and identifying the companies that can generate strong cash flows through this economic cycle and have strong competitive positions within their industries. For the pro-cyclical areas, we’re continuing to build our shopping lists while waiting for a better opportunity to increase our exposure to those areas of the market.
Debt Ceiling Debate
The role of the debt ceiling has been an increasing concern over the last few months and hit the front pages as talks ramped up ahead of today’s June 1st deadline. Congress must raise the debt ceiling in order to liquidate enough cash from the market to pay its bills and avoid defaulting on debt.
As such, we anticipated a true default as being essentially out of the question, though this does not mean that we couldn’t see a solution where the US Treasury is forced to prioritize debt-related payments over other expenses such as entitlements or government salaries.
With that said, the fight surrounding the debt ceiling has been noisy and is coming down to the last minute. As we saw in 2011, this can have serious implications for financial markets, and we anticipate that volatility may pick up as we move closer to the date on which we will breach the debt ceiling. In the end, a negotiated settlement is the likely outcome in which we see the debt limit temporarily raised in return for the promise to cut spending some time in the future.
We shared these views in our latest article, 5 Economic Updates and Our Views on Each, for more insight into other areas, read the full article here.
- Economic Cycle
- The economy is late cycle; the Fed is being forced by high and persistent inflation to tighten into an already weakening economy; a recession in the US is becoming increasingly likely
- Stock Market
- US stock market weakness has improved valuations, however, equities are not cheap by longer-term historical standards; valuations may be partly explained by robust corporate profitability, as EBIT margins climbed to historical highs in the years following covid lockdowns; elevated input costs and weakening demand are posing a risk to the ability of corporations to maintain this elevated level of profitability; returns will be harder to come by and stock selection will be increasingly important
- Bond Market
- Interest rates have risen well off their lows reflecting shifting expectations on inflation, growth, and central bank policy; corporate and municipal bond credit spreads have widened, but not enough to make them materially more attractive at this time
- Important Issues on the Radar
- Inflation: a confluence of massive policy stimulus, tight labor markets, gummed-up supply chains, and rising energy costs have caused inflationary forces to broaden and become more entrenched than previously expected
- Ukraine-Russia War: an environment of elevated geopolitical risk entails a general risk-off environment, lending upward support to the dollar, gold, and commodity prices
- China’s Economy: China has pivoted on the two key economic issues that acted as severe headwinds to growth over the last two years; we will now have to see how strong and sustainable the rebound in growth will be
Sources: Wall Street Journal, Bloomberg
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