Key takeaways
- Inflation, housing and jobs data all pointing the right direction for taming high inflation while avoiding a recession
- But the debt-ceiling crisis is putting pressure on the markets as the deadline draws closer
- If the US defaults on its debt, then the financial consequences would be severe and would almost certainly trigger a deep recession
Is the US heading for a recession? It feels like we’ve been asking this question for far too long, yet the danger – and rumors – still persist as long as the Fed’s battle against inflation rages. While the data looks fairly solid, some clouds are still on the horizon with jobs and inflation that could tip the probability of a recession in the US.
But the debt-ceiling drama is another factor to consider, even though the government will likely find a solution before the dreaded US debt default actually happens. The stock market has remained surprisingly calm amid the saga. Let’s get into the details.
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How is the data looking?
At the last meeting in May, the Fed raised interest rates to highs not seen since 2007. The target interest rate in the US is now 5% to 5.25%. Since then, investors and analysts have largely priced in an anticipated interest rate pause in June – the CME FedWatch tool puts an interest rate paise as 76.6% likely – but the deal is far from done.
Fed chair Jerome Powell said last week that stresses in the banking sector could mean “our policy rate may not need to rise as much as it would have otherwise to achieve our goals”, giving further weight to the anticipated pause. Powell was still keen to point out that inflation was too high and the Fed would continue to be led by the data.
The latest data has undoubtedly given the Fed some much-needed encouragement. Last month’s consumer price index (CPI) data revealed US inflation had fallen below 5% for the first time in two years, while the US job openings rate has fallen 1.5 percentage points since its peak.
But we’re not out of the woods yet. May figures for the Manufacturing and Services Purchasing Managers’ Indexes are released later today, with the report expected to be below April’s result, while May’s CPI could make no progress at all thanks to increasingly high housing and rent costs.
Powell and other Fed leaders also noted last week the effect of record-low unemployment, currently at 3.4%, on keeping inflation high. “I do think that labor market slack is likely to be an increasingly important factor in inflation going forward,” Powell said.
In a nutshell: the US has made some progress, but there’s still a long way to go and nothing is off the table.
The debt-ceiling crisis’ role in a potential recession
There’s still no agreement on how the US government plans to pay its bills in a scenario akin to 2011’s default crisis. As we inch closer to the June 1 deadline that US Treasury Secretary Janet Yellen set, the government now faces the prospect of running out of time to pay even if an agreement is reached.
If the US defaults on its debts, the stock market would almost certainly crash; the housing market could implode as interest rates spike and Social Security benefits could be at risk. And yes, the US would surely enter a massive recession, followed by the rest of the world.
But the most significant loss would be the US’ reputation on the global stage. The US dollar is the world’s reserve currency because the US economy is the biggest and therefore considered the most stable. Why would petty political squabbling jeopardize that?
It’s such an ‘own goal’ that it just doesn’t bear thinking about. It’s probably why Wall Street isn’t too phased by the situation either, despite ongoing market volatility.
How are the markets doing?
Before the debt-ceiling saga intensified, the markets had been buoyed by the latest data sets that showed inflation dropping and the jobs market cooling down. But since then, the drama has dominated the markets and will continue to do so until an agreement is reached.
In 2011 the S&P 500 slumped 17% around the time of the debt default deadline, taking weeks afterwards to recover from the situation. Investors could see the same happen in as soon as the next few days if we don’t see President Biden hammer out a deal with the Republicans.
But as it stands, the stock market is holding up relatively well. The S&P 500 has gained 1.34% in the last month, the Dow Jones Industrial Average has dipped 1.74% and the Nasdaq is up 5.68%, buoyed by a potential rate hold.
US stock futures were relatively flat on Tuesday morning, with the Dow Jones Industrial Average and S&P 500 futures both 0.2% lower and the Nasdaq 100 futures 0.1% down, reflecting a dour mood after not seeing much progress from President Biden’s meeting with Speaker McCarthy.
As predicted, US Treasury shorter-term yields haven’t been too hot with all of the debt-ceiling drama. The two-year yield was up three basis points to 4.3544% on Tuesday, while the 10-year yield remained relatively unchanged, falling less than one basis point to 3.713%. The one-month yield is trading at a record high of 5.718%.
The bottom line
Is a recession on the way? If the unthinkable happens and the world’s most prosperous economy kamikazes itself, then yes. But that’s (hopefully) extremely unlikely, so if we focus on the longer-term factors driving inflation, like jobs and CPI, we have a more accurate picture.
The US is doing better than Europe and the UK currently in fighting inflation, but the Fed’s warnings about record unemployment shouldn’t be ignored. The longer the battle goes on, the more difficult it will be to avoid at least a shallow recession in the US. While we could see an interest rate pause for now, the stock market doesn’t seem too worried either way.
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