For much of the latter part of last year we were watching the most aggressive rate hikes in decades from the Federal Reserve. The goal of the Fed was to slow the pace of inflation and attempt to bring it back in line with its 2% annual target rate. As we shared, our expectation was to see disinflation this year (inflation but at a slower pace in 2023) and this has occurred. However, inflation remains stubbornly high and the Fed Chair Jerome Powell has continued to raise rates, albeit at a slower pace, at every one of their meetings this year. On May 3, the Fed announced another 0.25% rate hike but hinted we may be near the end of this tightening cycle.
With the combination of the aggressive rate hikes and poor risk management decisions by some banks, there have been 3 large bank failures* so far this year. The banking industry concerns have forced the Fed to reevaluate the tools (rate hikes) they are using to rein in inflation.
Still, economic storm clouds on the horizon (inverted yield curve, decline in Leading Economic Indicators, and tightening of bank lending standards) seem likely to affect the economy in the next 12 months based on history.
“Usually, recessions sneak up on us. CEOs never talk about recessions,” economist Mark Zandi of Moody’s Analytics said late last year. “Now it seems CEOs are falling over themselves to say we’re falling into a recession. …Every person on TV says recession. Every economist says recession. I’ve never seen anything like it.”
Even the Federal Reserve, which rarely talks recession in advance, expects a mild recession to develop later in the year.
Given market action this past month, investors aren’t yet betting on a recession. Through the end of April the S&P 500 was up nearly 7% on the year (Thomson One).
Debt ceiling drama
The U.S. Treasury is running up against its ability to borrow to finance government spending, possibly as soon as early June, according to the Secretary of the Treasury Janet Yellen.
Without an increase, the U.S risks default. Republicans and Democrats are far apart in negotiations, but a default is almost unthinkable. We believe a compromise will be reached that raises the debt ceiling since the failure to do so could lead to severe consequences for financial markets and the economy.
It should also be noted that even if the debt ceiling were not raised, the debt could still likely be paid while other services would likely be cut first. Legal scholars have also begun to debate whether the debt ceiling itself is constitutional based on protections solidified in the 14th amendment.
A similar situation occurred in 2011, when a then divided government went to the “eleventh hour” to come to a resolution on raising the debt ceiling (the statutory maximum of money the Treasury is allowed to borrow). This caused a downgrade of our government debt by the rating agencies for a period of time and the stock market declined nearly 17% (according to Yahoo Finance).
We are not necessarily predicting the same outcome but with all the uncertainty related to this and the slowing economy, our team is still suggesting a cautious approach toward asset allocation.
If you have any questions or would like to discuss any matters, please feel free to give me or any of my team a call.
As always, our team is honored and humbled that you have given us the opportunity to serve as your financial advisor.
*FDIC Failed Bank List Updated 5.01.23
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Investing involves risk including loss of principal.