It’s not just the debt ceiling

It’s not just the debt ceiling

“Once the debt crisis is over, the spotlight is likely to shift back to the Federal Reserve,” Daleep Singh, global chief economist at 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 trio of risks,” he said. These include:

  • The potential for economic drag from the tighter 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 tight monetary policy. Is a recession on the way? Is inflation overdue? Should the Fed raise rates further, keep them where they are, or start cutting them to avoid a downturn?

  • The possibility of new outbreaks in the banking system. Regional banks like Silicon Valley Bank and Signature Bank were bailed out by regulators, First Republic was acquired by JPMorgan Chase and banks like PacWest, Western Alliance, Comerica and Zions Bancorp are under pressure. Bank runs and long-term investment losses, exacerbated by the Fed’s policy of raising interest rates, could resume if the Fed keeps rates at current levels or raises them further.

Strangely, the debt ceiling crisis has provided temporary relief for many of the country’s banks, economists at Moody’s Investor Service found in a recent study. “The debt ceiling stalemate has been a tailwind for banks,” Jill Cetina, deputy managing director of Moody’s, said in an interview.

But once the debt ceiling is lifted and the Treasury starts raising money by selling large amounts of bonds, these purchases by investors on the open market will drain the banks of money. “This might not be what you would expect, but resolving the debt ceiling crisis will be a hurdle for banks,” she said.

Global tensions remain high. Russia’s war in Ukraine continues, at a staggering cost. Russia and China, its backers, if not formal allies, are nuclear powers, and as NATO countries provide Ukraine with increasingly lethal military aid, the threat of a tragic escalation of the conflict cannot be entirely ruled out. From a purely economic point of view, although energy prices have fallen sharply from their wartime peaks in Ukraine, the possibility of further unexpected shocks remains. US-China relations are tense and global trade relations are strained.

Furthermore, even though the emergency phase of the pandemic is over in the United States and many other countries, the coronavirus is still with us and continues to exact a heavy toll in deaths and suffering. In the week of May 4 alone, 840 people died from the virus in the United States, bringing the rising death count to 1,133,684. Tens of thousands of people suffer from the long-term effects of the disease.

In an economic sense, the effects of Covid-19 are still with us. The expansive fiscal and monetary policies adopted to combat the Covid-induced recession in 2020 were remarkably successful in restoring economic growth. But the surge in inflation that has spread across global economies over the past two years is also partly due to those policies and the supply shocks generated by the virus. Even if the coronavirus does not break out again in the United States, the economy and markets are still readjusting, putting the Federal Reserve in a quandary, and countries like China continue to face severe outbreaks.


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