June 1, 2023 – President Biden and Speaker McCarthy agreed in principle to a two-year debt ceiling extension over the weekend, likely removing the risk of a debt ceiling breach. From a market standpoint, the news may cause a temporary knee-jerk rally, but I don’t think this will necessarily be a sustainable positive, as extending the debt ceiling merely removes a potential catastrophic negative and does not add anything new and positive into the macro set up. Conversely, the deal will not be a material negative for growth, either, as it does not drastically put more pressure on an already slowing economy by reducing federal spending.
From a “What’s Next?” standpoint, last Friday Secretary Yellen cited June 5 (next Monday) as the “X” date where the U.S. hits the ceiling. So, it is expected that the House of Representatives will vote on the measure on Wednesday, the Senate will vote on Friday, and Biden will sign the extension before Monday. While this agreement is likely to pass, I would not be shocked if there are some last-minute threats of lack of support, posturing and drama that may inject volatility into the markets. Regardless, the debt ceiling should soon be behind us, I don’t think it will be a material market influence, and it will allow our focus to turn to more important matters such as hard landing vs. soft landing, inflation, and whether the Fed hikes on June 14, which I will address next.
The U.S. stock market (as measured by the S&P 500 index) has been trading range bound (“stuck”) since the start of the year between 3,800 to 4,200. With Memorial Day over, investors will start to look forward to summer, and I think we will begin to see the resolution on three key issues that will “unstuck” markets, either higher or lower.
In the order of importance, I see the key issues being 1) hard/soft landing, 2) inflation, and 3) Fed policy.
Hard/soft landing – I rank this as the number one issue because the stakes are high. If there is a hard landing[1], then stocks can drop, potentially a lot, from current levels. On the other hand, with so much money on the sidelines, if the Fed can stick a soft landing[2], then stocks can potentially rally, a lot, as investors become more risk on and chase markets higher.
The two economic indicators most followed by analysts and economists are the ISM[3]® Report on Business® – Manufacturing (PMI[4]®) and Services (PMI®). US ISM Manufacturing PMI is at a current level of 47.10 (contraction), down from 55.40 one year ago. This is a change of -14.98%; US ISM Services PMI is at a current level of 51.90 (expansion). One year ago, the Services PMI level was at 57.10.
Based on the above, the hard landing/soft landing resolution seems to rest on the service economy. Services have been resilient because they are linked to consumer spending, which I don’t think will materially drop until the unemployment rate starts to rise. The latest unemployment rate is 3.40%[5], if the unemployment rate rises through the summer (say we end the summer above 4.0%), then I would see it as a sign the recession has started, and it may be negative for stocks. New unemployment rates will be released tomorrow, June 2nd, and I am certain it will be closely watched by analysts and the Fed alike.
Inflation – At 4.90%, inflation (CPI) has come down substantially since it peaked at 9.1%[6] in June, 2022. As I have said in the past, the CPI that matters is the one that is watched by the Fed, which is the core CPI. The core CPI is the headline CPI excluding energy and foods. Core CPI is still sticky at 5.54%[7]. In my view, the core inflation needs to track below 5.0% by the end of the summer (and the closer to 4.0%, the better). If that happens, it would be a positive for stocks, long-dated bonds, growth/tech, and commodities, negative for the U.S. dollar. If that does not happen, it would be negative for stocks and bonds, and it should lead to relative outperformance from defensives and low volatility ETFs. CPI will be a critical data point to watch this summer.
Fed policy – The question now is whether the Fed pause has happened, and when does the pivot occur? The Fed’s decision will be on June 14th, one day after the CPI date. Does the Fed hold rates steady? I suspect the answer will partly be influenced by the core CPI number. If the Fed holds rates steady, it will be a positive development for markets; otherwise, it may increase market volatility.
Also depending on inflation, unemployment rate, and other economic data such as the ISM’s PMI indexes, the Fed will most likely determine whether it will cut rates in the final quarter of the year. Currently the bond market (often heralded as the smart money) is expecting a >70%[8] of at least a .25%[9] rate cut before the end of the year. But as I wrote above, whether it happens or not will be very much data driven.
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[1] A hard landing refers to a marked economic slowdown or downturn following a period of rapid growth. The term “hard landing” comes from aviation, where it refers to the kind of high-speed landing that—while not an actual crash—is a source of stress as well as potential damage and injury.
[2] A soft landing, in economics, is a cyclical slowdown in economic growth that avoids recession. A soft landing is the goal of a central bank when it seeks to raise interest rates just enough to stop an economy from overheating and experiencing high inflation, without causing a severe downturn.
[3] ISM is Institute for Supply Management, a non-profit supply management association.
[4] PMI is Purchasing Manager Index. These two indexes are published monthly by the ISM Manufacturing and Services business survey committees. They are considered to be among the most reliable economic indicators. A PMI reading over 50 (or over 50%) means the sector is growing compared to the previous month, while a PMI reading under 50 (or under 50%) means the sector has month-over-month contracted.
Debt Ceiling Update & Summer Catalyst Cheatsheet
By John Lau
June 1, 2023 – President Biden and Speaker McCarthy agreed in principle to a two-year debt ceiling extension over the weekend, likely removing the risk of a debt ceiling breach. From a market standpoint, the news may cause a temporary knee-jerk rally, but I don’t think this will necessarily be a sustainable positive, as extending the debt ceiling merely removes a potential catastrophic negative and does not add anything new and positive into the macro set up. Conversely, the deal will not be a material negative for growth, either, as it does not drastically put more pressure on an already slowing economy by reducing federal spending.
From a “What’s Next?” standpoint, last Friday Secretary Yellen cited June 5 (next Monday) as the “X” date where the U.S. hits the ceiling. So, it is expected that the House of Representatives will vote on the measure on Wednesday, the Senate will vote on Friday, and Biden will sign the extension before Monday. While this agreement is likely to pass, I would not be shocked if there are some last-minute threats of lack of support, posturing and drama that may inject volatility into the markets. Regardless, the debt ceiling should soon be behind us, I don’t think it will be a material market influence, and it will allow our focus to turn to more important matters such as hard landing vs. soft landing, inflation, and whether the Fed hikes on June 14, which I will address next.
The U.S. stock market (as measured by the S&P 500 index) has been trading range bound (“stuck”) since the start of the year between 3,800 to 4,200. With Memorial Day over, investors will start to look forward to summer, and I think we will begin to see the resolution on three key issues that will “unstuck” markets, either higher or lower.
In the order of importance, I see the key issues being 1) hard/soft landing, 2) inflation, and 3) Fed policy.
Hard/soft landing – I rank this as the number one issue because the stakes are high. If there is a hard landing[1], then stocks can drop, potentially a lot, from current levels. On the other hand, with so much money on the sidelines, if the Fed can stick a soft landing[2], then stocks can potentially rally, a lot, as investors become more risk on and chase markets higher.
The two economic indicators most followed by analysts and economists are the ISM[3]® Report on Business® – Manufacturing (PMI[4]®) and Services (PMI®). US ISM Manufacturing PMI is at a current level of 47.10 (contraction), down from 55.40 one year ago. This is a change of -14.98%; US ISM Services PMI is at a current level of 51.90 (expansion). One year ago, the Services PMI level was at 57.10.
Based on the above, the hard landing/soft landing resolution seems to rest on the service economy. Services have been resilient because they are linked to consumer spending, which I don’t think will materially drop until the unemployment rate starts to rise. The latest unemployment rate is 3.40%[5], if the unemployment rate rises through the summer (say we end the summer above 4.0%), then I would see it as a sign the recession has started, and it may be negative for stocks. New unemployment rates will be released tomorrow, June 2nd, and I am certain it will be closely watched by analysts and the Fed alike.
Inflation – At 4.90%, inflation (CPI) has come down substantially since it peaked at 9.1%[6] in June, 2022. As I have said in the past, the CPI that matters is the one that is watched by the Fed, which is the core CPI. The core CPI is the headline CPI excluding energy and foods. Core CPI is still sticky at 5.54%[7]. In my view, the core inflation needs to track below 5.0% by the end of the summer (and the closer to 4.0%, the better). If that happens, it would be a positive for stocks, long-dated bonds, growth/tech, and commodities, negative for the U.S. dollar. If that does not happen, it would be negative for stocks and bonds, and it should lead to relative outperformance from defensives and low volatility ETFs. CPI will be a critical data point to watch this summer.
Fed policy – The question now is whether the Fed pause has happened, and when does the pivot occur? The Fed’s decision will be on June 14th, one day after the CPI date. Does the Fed hold rates steady? I suspect the answer will partly be influenced by the core CPI number. If the Fed holds rates steady, it will be a positive development for markets; otherwise, it may increase market volatility.
Also depending on inflation, unemployment rate, and other economic data such as the ISM’s PMI indexes, the Fed will most likely determine whether it will cut rates in the final quarter of the year. Currently the bond market (often heralded as the smart money) is expecting a >70%[8] of at least a .25%[9] rate cut before the end of the year. But as I wrote above, whether it happens or not will be very much data driven.
See below for a Summer Catalyst Cheat Sheet for the economic data shared in this blog post. It includes the release dates, and my personal assessment of what I think is good or bad. For those of you who are so inclined, it may be fun to track. I will definitely be tracking them closely as a guide to the way I manage my clients’ accounts.
Summer Catalyst Cheat Sheet
Bad: no cuts in 2023
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Securities offered through Fortune Financial Services, Inc. Member FINRA/SIPC. Robertson Stephens Wealth Management, LLC and Fortune Financial Services, Inc. are separate entities and are not affiliated.
[1] A hard landing refers to a marked economic slowdown or downturn following a period of rapid growth. The term “hard landing” comes from aviation, where it refers to the kind of high-speed landing that—while not an actual crash—is a source of stress as well as potential damage and injury.
[2] A soft landing, in economics, is a cyclical slowdown in economic growth that avoids recession. A soft landing is the goal of a central bank when it seeks to raise interest rates just enough to stop an economy from overheating and experiencing high inflation, without causing a severe downturn.
[3] ISM is Institute for Supply Management, a non-profit supply management association.
[4] PMI is Purchasing Manager Index. These two indexes are published monthly by the ISM Manufacturing and Services business survey committees. They are considered to be among the most reliable economic indicators. A PMI reading over 50 (or over 50%) means the sector is growing compared to the previous month, while a PMI reading under 50 (or under 50%) means the sector has month-over-month contracted.
[5] Bureau of Labor Statistics, May 5, 2023
[6] Bureau of Labor Statistics
[7] Ibid
[8] CME Fed Watch
[9] Ibid
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