“Once the debt crisis is behind us, the focus of attention is likely to shift back to the Federal Reserve,” Daleep Singh, the chief global economist for PGIM Fixed Income, said in an interview. The Fed has been raising interest rates since March 2022 in its battle with inflation, and needs to decide what to do at its next meeting in June. “The Fed faces a trifecta of risks,” he said. These include:
The potential for economic drag from the more restrictive fiscal policy that House Republicans are demanding from President Biden as a prerequisite for an increase in the debt ceiling.
The lagged effects of the Fed’s restrictive monetary policy. Is a recession on the way? Is inflation vanquished? Should the Fed raise rates further, hold them where they are or begin to cut them to avoid a downturn?
The possibility of renewed flare-ups in the banking system. Regional banks like Silicon Valley Bank and Signature Bank have been rescued by regulators, First Republic was acquired by JPMorgan Chase, and banks like PacWest, Western Alliance, Comerica and Zions Bancorp have come under pressure. Bank runs and losses on long-term investments, aggravated by the Fed’s policy of raising interest rates, could resume if the Fed holds rates at current levels or raises them further.
Oddly, the debt ceiling crisis provided temporary relief for many of the nation’s banks, economists for Moody’s Investor Service found in a recent study. “The debt ceiling impasse has been a tailwind for the banks,” Jill Cetina, associate managing director for Moody’s, said in an interview.
But once the debt ceiling is lifted and the Treasury begins to raise money by selling large quantities of bonds, those purchases by investors in the open market will drain money from banks. “This may not be what you would expect, but the resolution of the debt ceiling crisis will be a headwind for banks,” she said.
Global tensions remain high. Russia’s war in Ukraine grinds on, at a staggering cost. Russia and China, its supporter, if not formal ally, are nuclear powers, and as NATO countries provide increasingly lethal military aid to Ukraine, the threat of a tragic escalation of the conflict can’t be entirely dismissed. From a purely economic standpoint, while energy prices have dropped sharply from their peaks at the start of the Ukraine war, the possibility of further unexpected shocks remains. U.S.-Chinese relations are fraught, and global trade relationships have been fraying.
On top of that, while the emergency phase of the pandemic has ended in the United States and many other countries, the coronavirus is still with us, and it continues to exact a harsh toll in death and suffering. In the week of May 4 alone, 840 people died of the virus in the United States, bringing the steadily rising death count to 1,133,684. Scores of thousands of people suffer from the disease’s long-term effects.
In an economic sense, the effects of Covid-19 are still with us, too. The expansive fiscal and monetary policies enacted to combat the recession induced by Covid in 2020 were strikingly successful in restoring economic growth. But the bout of inflation that has spread through global economies in the past two years also stems partly from those policies and the supply shocks engendered by the virus. Even if the coronavirus does not erupt again in the United States, the economy and the markets are still readjusting, putting the Federal Reserve in a quandary, and countries like China continue to experience serious outbreaks.
So for investors who may have been lulled by the rise of the stock market in the United States, I’d say, hang in there — but be careful.
There are too many variables at the moment to be able to predict which way we’re heading this year.
What are we facing in the months ahead? Recession? Stagflation? A soft landing? A new tech boom powered by artificial intelligence?