Evening Brief – 05.26.23

President Biden and House Speaker McCarthy are reportedly close to reaching a deal that would raise the debt ceiling for two years. The deal would include spending caps on almost everything except defense.

It appears that in a case where there is insufficient cash, the administration will attempt to favor bondholders in order to avoid an official default and the ensuing substantial financial market repercussions. However, we are not experiencing the strain that a potential default would bring about. While some money market rates have risen, longer-term yields hardly seem to be responding, and the S&P500 even made up some of the ground it had lost since the start of the week.

The impact of the economy’s current outperformance appears to be greater than the risk associated with exceeding the debt cap. Yet, while some Fed officials have advocated for an intervention in the event of unrest, the possibility of default doesn’t appear to allow for a policy pivot.

There is an obvious difference of opinions about whether the Fed should pause or continue to hike rates. Comments (Meister, Kashkari, Logan to name a few) throughout the week and Wednesday’s FOMC minutes from the previous meeting highlighted that disagreement.

The likelihood of a pause in June is still high, but if the Fed’s anticipated credit tightening does not occur, additional hikes after that meeting may be necessary to bring inflationary pressure under control.; one of the Fed’s favorite inflation indicators – Core PCE Deflator – printed hotter than expected in April with headline and core both +0.4% versus expectations of +0.3%, pushing the year-over-year inflation rate higher.

Fed-talk, the minutes, good economic data and upwardly revised inflation, have led to the market pushing back its expectations of a Fed pivot to the end of this year or early in Q1 2024. In fact, a July rate hike is now almost fully priced in.