By Jan Faure
The US Congress finally approved a deal to lift America's borrowing limit, averting the alarming prospect of the US defaulting on its $31 trillion debt, which underpins the global financial system. The US government was forecast to reach its borrowing limit around the 5th of June. A default would have meant the government would not have been able to borrow or pay all its bills. This is not the first time the acrimonious nature of US politics has taken the American economy to the brink of default.
Concerns over the US debt ceiling were a drag on global stocks and bonds throughout May. Large-cap technology stocks were the exception, which continued to rally as investors clamoured for companies exposed to “generative AI” technology, largely due to the buzz surrounding OpenAI’s ChatGPT. The primary target was Nvidia (up over 170% YTD), known for its gaming GPUs (graphics processing units). Nvidia briefly joined the $1 trillion market-cap club before settling slightly lower.
Gains in large tech stocks, notably Nvidia, Alphabet, Microsoft and Meta, saw the Nasdaq index climb 5.8% in May, and also helped the S&P500 index eke out a 0.2% gain for the month. The Dow Jones index, which comprises less technology companies, fell 3.5% in May (-0.7% YTD). In Europe, the Euro Stoxx 50 declined 3.2% in May while the UK’s FTSE 100 dropped 5.4%. German GDP data indicated that Europe’s largest economy is in recession following two quarters of contraction.
As expected, the European Central Bank (ECB) raised interest rates by 25 basis points to 3.25%. With inflation elevated, markets expect the ECB to hike rates at least another two to three times before ending the tightening cycle. Headline and core inflation have both been easing in Europe and the UK. The preliminary Consumer Price Index (CPI) reading for May showed Eurozone headline inflation at 6.1% year-on-year (YoY), down from 7.0% in April. UK inflation eased to 8.7% YoY in April from 10.1% in March.
In Asia, Japan’s Nikkei 225 index gained 7.0% while Hong Kong’s Hang Seng index declined by 8.3%. Chinese equity indices also declined sharply, driven by a slowing Chinese economy, a lack of any meaningful stimulus and ongoing geopolitical tensions with the West. Slower domestic Chinese demand has been a positive for global inflation as inventories build-up. This may lead Chinese manufacturers to export goods at lower prices creating a potential deflationary impact on global goods prices.
The US Federal Reserve (Fed) increased benchmark interest rates, as expected, by another 25 basis points, raising the target rate to 5.00% - 5.25%. This tenth increase in a row takes interest rates to the highest level since September 2007. The Fed said it would pivot to making decisions on a meeting-by-meeting basis, opening the door to a pause in further rate hikes, although this would be data dependent. The Fed said they would factor data on inflation, labour-markets and credit conditions into future policy. Fed chairman Powell noted that the job market is still very tight (unemployment rate is at its lowest level since 1969) and highlighted uncertainty over the impact of tighter credit conditions from US banks on the economy.
US headline inflation (CPI) declined slightly to 4.9% YoY in April from 5.0% in March. It marked the 10th consecutive decline in the year-on-year rate of inflation and the lowest level since April 2021. The inflation rate peaked at 9.1% in June 2022. Notably, the Fed funds rate now exceeds headline inflation, indicating that monetary policy is now becoming contractionary.
A US recession remains a major talking point as economic data supports an economic contraction later this year. The data includes the inverted yield curve, persistently weak manufacturing data, and US consumers and corporates coming under pressure from higher interest rates (and tighter lending standards). There are, however, mitigating factors such as the strong labour market, the robust services sector, and the Fed having replenished its policy levers to deal with an economic downturn. As such, we expect at worst a shallow recession in the US later this year, or by the first half of next year.
As daunting as it may sound, we do not expect one of the most anticipated US recessions in recent times to severely upend markets. Improving sentiment should provide a counterbalance that helps keep investors upbeat as the rate cycle peaks and employment holds up relatively well (far better than previous downturns). However, we acknowledge, and anticipate, a likely resurgence of higher volatility.
Table 1: Global Indicators – Local reporting currencies
