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Volume 12, Edition 2 | January 23 – January 27, 2023

Why You Should Ignore the Debt Ceiling Drama

Doug Walters, CFA
Debt ceiling debates have begun again, and with them, sensational headlines of impending doom. Don’t get sucked in.

Contributed by Doug Walters, Max Berkovich, David Lemire, Eh Ka Paw

Here we go again! Once again, the debt ceiling debates have hit Washington with threats of government shutdowns and the unthinkable default on US debt.

Background

Congress sets a legislative maximum (“ceiling”) on the debt the Treasury can incur. We are at that level, and the Treasury is taking “extraordinary measures” to pay expenses and ensure obligations on borrowings are met (i.e. we pay what is owed to our creditors). Treasury Secretary Yellen believes these measures will allow the US to meet its obligations until early June.

Paying our previous obligations is a no-brainer, so what’s the problem? There’s a standoff in Washington. The newly appointed House Speaker was elected with the promise that spending cuts accompany the debt ceiling increase. The President wants no strings attached.

We’ve been here before. This is not new territory. Debt ceiling increases are regularly used as leverage for politicians to achieve their agenda. In the end, a deal always seems to get done. With that said, S&P did downgrade US sovereign debt from AAA to AA+ in 2011, calling out the political shenanigans around the process.

Our take… the next five months will be full of sensational headlines of impending doom, and in the end, a deal gets done. We can’t predict the future, though. The US could theoretically default; it’s just very unlikely. The best thing investors can do is ignore the inevitable grandstanding over the next five months. In addition (and as always), we recommend investors maintain well-diversified portfolios and put in place a process that will take advantage of any opportunities that arise if the unexpected happens.

Headline of the Week

PCE and GDP

Two big economic reports came out this week with important but hard-to-discern impacts on the economic and Fed policy direction. Basically, whatever case you care to make for recovery/recession or Fed policy, there was information to support your view.

First, PCE or personal consumption expenditures which is the Fed’s preferred inflation measure, indicates it is holding steady at a slightly lower level than a few months ago. However, it is still above pre-pandemic levels and Fed targets. The new “supercore” tells a similar tale. Many Fed officials indicated that they will dial back their interest rate increases next week but that rates will stay still higher for longer to confirm inflation’s defeat.

Next, GDP, or gross domestic product, which measures the economy’s overall output showed some resilience to end the year, but signs of potential weakness were beneath the headline numbers. The Fed is trying to restrain GDP growth without pushing us into recession – the soft landing.

Encouraging or discouraging is in the eyes of the beholder.

The Week Ahead

What a week, three of the world’s biggest central banks have rate decisions, a jobs report, and earnings from tech giants.

Big Bank

The Federal Reserve, European Central Bank, and Bank of England are facing rate decisions next week.

  • Expectations are for a half of a percent hike for the European Central Bank (ECB), but the path of further hikes remains murky over there.
  • ECB President Lagarde is expected to maintain a hawkish tone, to keep the markets from jumping the gun and start running ahead of the bank. Bank of England (BOE) is poised for a half of a percent hike as well, but the market is expecting this to be a quarter of a percent away from the peak.
  • Will it be 50 basis points this time, and 25 in March or 25 for three meetings is the big question that needs to be sorted out.
  • Last and most important is the Federal Reserve Bank (Fed), which is expected to serve up a quarter of a percent hike, bringing the rate range to 4.5% – 4.75%.
  • The terminal rate of 5% seems to be very close, this is the point at which the Fed is expected to stop hiking and start evaluating the effectiveness of the previous hikes.
  • While, as always, a deviation from consensus will disturb the markets, the tone in the press conferences could also shake things up.

Payroll JOLT

U.S. Non-Farm Payroll report on the first Friday of the new month will hopefully bring another upside surprise. So far, the report has come in above consensus since April.

  • The unemployment rate at 3.5% is a 50-year low and thus far, the Fed tightening hasn’t derailed it.
  • With a week to go, the consensus of Economists is for a mere 16,000 jobs created in January, as the average for all of 2022 was roughly 375,000 each month.
  • A weak employment report would indicate the battle to tame inflation is succeeding. However, we don’t like having people lose their jobs. Leaving us cheering for both teams to win!
  • Other data that the labor department will release will include the labor participation rate, which is expected to tick down a bit, and hourly earnings, which are expected to climb some.
  • There is also a Job Openings and Labor Turnover Survey (JOLTS) report for December coming out, which should shed light on how much slack there is in the labor market.

Technically Speaking

Big week of earnings in store, with the biggest day being Thursday.

  • McDonald’s Corp (MCD), Pfizer, Inc. (PFE), Exxon Mobile Corp. (XOM), and United Parcel Service, Inc. (UPS) get the ball rolling on Tuesday.
  • Meta Platforms, Inc. (META), formerly Facebook, reporting on Wednesday, will be the appetizer before the main course on Thursday.
  • Alphabet, Inc. (GOOG, GOOGL), Apple Inc. (AAPL), and Amazon, Inc. (AMZN) will battle each other for airtime on Thursday after the market close.
  • These three companies represent over $4.6 Trillion of Market Capitalization and each stock had an awful 2022, down over 25%, with Amazon down almost 50%.

Other Noise

Gross Domestic Product (GDP) from the European Union and Purchasing Manger Index from the Institute of Supply Management (PMI) are the other big economic releases next week.

  • The GDP in Europe is expected to have expanded in the 4th quarter and avoided a recession.
  • The PMIs are expected to have improved from the previous month, while the services flavor of the report is expected to jump back above 50, which indicates expansion the manufacturing report is expected to still come in below 50.

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