The broad stock and bond markets experienced ongoing recoveries against a backdrop of uncertainty in April.
US stocks have risen almost 8% for the year, with developed markets up 10% and developing markets up 3%. The 10-year US Treasury rate has declined from 3.88% at the beginning of the year to 3.44% at the end of April, and in turn bond prices have risen in the 2-4% range.
This ongoing recovery from the significant declines in the stock and bond markets in 2022 has occurred against a backdrop of several issues that we’ve covered extensively in recent months:
Prices continue to fall, although not necessarily at the pace favored by central bankers around the world.
In the US, inflation is now in the 5% range, compared with 9% recently. The Federal Reserve raised interest rates again on May 3 by one quarter percent, to about 5%, in its continuing efforts to rein in the economy without causing a recession.
Fed Chair Jerome Powell has said that he sees the possibility of the hoped-for soft landing reflected in continuing strength in the US labor market. “‘That’s not my own most likely case,’ he said, explaining that he expects modest growth rather than recession this year. … ‘There are no promises in this, but it just seems to me that it is possible that we can continue to have a cooling in the labor market without having the big increases in unemployment that have gone with many prior episodes.’”
In Europe, the European Central Bank also raised interest rates by one quarter percent. But whereas many observers think the US might be done with rate increases, the ECB has indicated that it plans to continue tightening.
“Even as the central bank, which sets the rates for the 20 countries that use the euro, slowed down the pace of its monetary policy tightening, Christine Lagarde, the president of the bank, made plain that the fight against inflation was not complete. ‘We are not pausing … we know we have more ground to cover.’”
Turmoil in the banking industry continued, as JP Morgan Chase agreed to buy First Republic Bank after regulators assumed billions of dollars of potential losses lurking on First Republic’s books. This follows the failures and subsequent purchases of Silicon Valley Bank and Signature Bank. Other small to mid-sized regional banks, including PacWest and Western Alliance, continued to experience major stock price declines as investors try to figure out which bank might fail next.
According to Amit Seru, a Stanford Economics professor, “While some experts and policy makers believe that the resolution of First Republic Bank on Monday indicates that the banking turbulence is coming to an end, I believe this may be premature. Adverse conditions have weakened the ability of many banks to withstand another credit shock – and a big one may be on its way.”
“While the government’s efforts [in finding buyers for the three failed banks and extending deposit insurance to bank customers] have stabilized the situation somewhat for now, it is far too early to declare victory. Midsize and small banks play a vital role in lending to local businesses, and their insolvency could lead to a severe credit crunch with adverse effects on the real economy, particularly in regions with lower household incomes. At the same time, the risks of moral hazard [the incentive to take additional risks when the government agrees to extend protections like deposit insurance] lurk in the shadows.”
US Debt Ceiling
This issue presents perhaps the most uncertainty (see “What the Debt Limit Might Mean for Investors” for additional background). President Biden and the leaders of the House and Senate met on May 9 to discuss a potential resolution, but the two sides seem as far apart as ever with a potential June 1 deadline looming.
Since the US has never defaulted on its debt before (despite coming close previously, most recently in 2011), no one really knows what the repercussions would be, although most observers agree they would generally be very damaging to the US and world economies, and likely stock and bond markets as well.
A recent New York Times article outlined four possible ways to resolve the crisis, including:
- Staying the course: “Biden has insisted for months that lawmakers must raise the nation’s borrowing cap with no conditions attached, saying that it simply allows the US to pay for spending Congress has already authorized.”
- Negotiate spending cuts not tied to the debt limit: “Biden could negotiate without ‘negotiating’ by trying to broker an early agreement on spending levels for the next fiscal year … In exchange, Republicans would commit to passing a clean extension of the debt limit.”
- Bypass House Speaker McCarthy: “Biden could court a handful of moderate Republicans in the House and Senate to vote to raise the limit, offering some fiscal concessions as an enticement.”
- Go It Alone: “Biden could pursue what is effectively a constitutional challenge to the debt ceiling by continuing to borrow to pay the bills … rooted in a clause in the 14th Amendment that stipulates that the government must pay its debts.”
New York Times columnist Paul Krugman argues that the President should try to negotiate to end the crisis, but not give in to what he terms “extortion” in order to reach an agreement.
PPA will be monitoring all these issues closely, and we’re always happy to discuss with you further.
Read “Ongoing Recoveries Against a Backdrop of Uncertainty” in the Piedmont Exedra.