2023-06-09 07:49:01
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- The US debt ceiling agreement allows breathing room
- The fundamentals back in the limelight
- The outlook for interest rates and the economy continues to argue for prudent portfolio positioning
With the agreement on the US debt ceiling, a decisive risk factor for the economy and the financial markets – the possible insolvency of the largest economy in the world – is no longer relevant. Last week, the second chamber of Congress, the Senate, also passed the debt compromise with surprising speed. This plans to suspend the current cap of 31.5 trillion US dollars until the beginning of 2025. In return, budgetary expenditure will be de facto slightly reduced, a key demand of the Republicans
Investors should certainly bear in mind that the US fiscal situation remains a medium-term challenge due to a huge debt mountain, rising government refinancing costs and a Congress split. Nevertheless, unsurprisingly, relief was felt, and not just in political Washington. In New York, US stock markets hit their highest level since the start of 2023.
The fundamental framework conditions back in the spotlight
From our point of view, it is decisive that the agreement on the debt conflict brings the attention of the financial markets back to the fundamental framework conditions. In short, the macroeconomic outlook remains marked in particular by:
First, falling inflation rates in the United States and the euro zone, but which remain stubbornly at levels well above the monetary policy target of 2% due to tensions in the labor markets (the Friday’s US jobs report surprised the consensus for the 14th consecutive time); second, still-restrictive key interest rate levels and continued quantitative tightening, ie the easing of monetary policy. that is to say, the withdrawal of central bank liquidity, in the United States and in the euro zone, which should, thirdly, leave more visible traces in the real economy during the year, and fourthly, a stalled post-Covid economic recovery in East Asia.
The encouraging message is that two crucial stumbling blocks for the markets have been eliminated in the meantime: The end of the US debt dispute and the end of the exaggerated interest rate cut fantasies in the US money markets. On the contrary, a debate has started on whether the American central bank (Fed) would announce a pause (“pause”) during its decision of June 14 or simply suspend the rate hike cycle (“skip”), that is, leaving the door wide open for further increases in the months to come. At the same time, the end of the European Central Bank (ECB) rate hike cycle is becoming increasingly predictable in the Eurozone.
But all this comes up once morest a rally in the flagship US S&P 500 index of around 11.5% since the start of the year (at the end of the week), which lacks momentum. On the contrary, the positive price development is exclusively due to ten of the 500 (!) shares whose market capitalization now represents around 30%. You have to go back more than two decades in the history of the S&P 500, to the third and fourth quarters of 1998, to find such a concentrated index. At the time, during the tech bubble, the top ten stocks accounted for between 31 and 36 percent.
The outlook for interest rates and the economy continues to argue for prudent portfolio positioning
On the one hand, we are keeping an eye on how financial markets are digesting the recovery in US Treasury issuance. We believe US Treasury (T-Bill) issuance might reach $1 trillion over the next few months, well above typical issuance levels outside of previous crises, such as the global financial crisis. of 2008/2009 and the Covid pandemic, and might, in our view, increase the volatility of fixed income securities, in particular at very short maturities. That’s why we’re adjusting our preference for short-term US government bonds and expanding the range of preferred maturities beyond short-term to include two-year US government bonds, which have been repriced over the past few weeks.
On the other hand, we are closely watching the hope, still present in the stock markets, of resilient growth in the economy and corporate profits on both sides of the Atlantic, accompanied by a trajectory smooth disinflation in developed countries towards the 2% monetary policy targets. In our view, the overall narrative on the six to twelve month horizon remains unchanged: In a world where supply factors dominate, whether due to demographic trends, global trade rewiring and/or green transformation economy, central banks are forced to curb growth in order to cool inflation. Both the Fed and the ECB will likely need to maintain their restrictive stance for an extended period.
In the United States, the pace of growth has already slowed markedly at the start of the year, in particular due to the tightening of financing conditions. For the second half, we still expect a decline in value creation. The German economy, for example, is already in a phase of weakness. An expansion of gross domestic product in the second quarter would likely only temporarily halt the contraction in economic performance of last winter.
Even the slight rise emerging – ultimately a contrary movement – in manufacturing production in April (Wednesday) should not be misleading. In the German manufacturing sector, all relevant leading indicators have darkened, including new orders, the purchasing managers’ index and, more recently, the Ifo business climate. Further economic weakness, and not only in Germany, should increasingly weigh on corporate earnings. At the same time, the latest economic indicators in East Asia have been disappointing, although the Asian region remains the engine of global growth this year and should, according to IMF estimates, contribute regarding two-thirds of global economic growth.
Investors should continue to brace for volatility in an environment where concerns regarding economic downside risks combine with financial cracks caused by steep central bank interest rate hikes. We believe that the risk of price reversals and increased fluctuation bands reinforces the need for careful portfolio positioning.
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