What’s Next for Markets after a Debt Ceiling Compromise?

Some believe the quote, “May you live in interesting times,” is a translated Chinese curse because of its irony. The current geopolitical environment has been an “interesting time” since President Xi shook hands with President Putin in February 2022 on a massive trade agreement and “no limits” alliance.

May 2023 has been an “interesting time” in the U.S. as political wrangling over the debt ceiling roiled markets. While a compromise that avoided default was always the best-odds case, raising the debt ceiling with the U.S. over $31.7 trillion in the hole is only part of the problem. Any individual or company with debts at that level would be insolvent. Increasing the debt ceiling kicks a giant can down the road as even balanced spending and revenues will cause the deficit to rise by over $1.6 trillion annually, with the Fed Funds Rate at 5.125%.

As the markets put the debt ceiling debacle and domestic political wrangling in the rearview mirror, more than a few issues will determine the path of least resistance of markets across all asset classes over the coming weeks and months. Markets reflect the economic and geopolitical landscapes, which remain highly volatile in late May 2023.

U.S. domestic politics- The election cycle takes center stage

• The 2024 Presidential election cycle is on the horizon.
• Voters will decide which candidate represents each party.
• A repeat of the 2020 election choices looks likely.
• Third-Party candidates could emerge.
• The U.S. remains politically divided on domestic and international issues.
  
  

Geopolitics- The Chinese-Russian alliance threatens the U.S. leadership position

• China and Russia have joined forces in a “no-limits” alliance.
• President Xi and President Putin pledged to shape a new world order with “changes that haven’t happened in 100 years.”
• A BRICS currency could challenge the U.S. dollar’s dominance as the world’s reserve foreign exchange instrument.
• The war in Ukraine continues, and China continues to move toward reunification with Taiwan.
• Tensions between Washington, DC, and Beijing/Moscow have dramatically increased.
   

Inflation remains at a multi-decade high

• S. and global inflation rates have moderated but remain at the highest levels in years if not decades.
• The war in Ukraine, sanctions on Russia, Russian retaliation, and tensions with China create supply-side logistical issues that fuel inflation beyond the world’s central banks’ monetary policy reach.
• The global pandemic created inflationary forces that continue to impact the global financial system.
  
  

Debt levels are not likely to decline

• The U.S. debt, at over $31.7 trillion, will rise by more than $1.6 trillion annually if revenues and spending are balanced.
• A compromise on the debt ceiling that avoids a U.S. default will only kick the can down the road until the deficit reaches the next ceiling.
• A recession, banking crisis, increasing military spending to counter China/Russia, and unforeseen events would only cause the debt level to grow exponentially.

The unknown is always the greatest danger for markets

• Markets reflect economics and geopolitics.
• As we learned during the 2020 global pandemic and Russia’s 2022 invasion of Ukraine, unforeseen events cause the most significant market volatility.
• Investors need to prepare for the worst and hope for the best.
• Optimism is essential for a healthy life, but over-optimism can have tragic financial consequences.
• The debt ceiling issue will fade into the market’s rearview mirror, but plenty of other lurking factors will likely cause across all asset classes.