Macro Outlook Retakes Spotlight

  • We see the market’s focus returning to higher-for-longer rates and sticky inflation after a U.S. debt ceiling deal. We prefer an up-in-quality portfolio.
  • U.S. stocks hit 2023 highs after the debt ceiling deal. Yields rose amid the specter of rate hikes after Friday’s payroll report showed a jump in new jobs.
  • China macro data is in focus this week. We trim our growth view slightly as the economic restart loses steam and policy reactions remain uncertain.

Last week’s U.S. debt ceiling deal removes near-term uncertainty and thrusts the market’s focus back to the macro picture: sticky inflation due to tight labor markets. We see rates staying higher for longer as a result. We keep a quality tilt in portfolios and prefer income for now. Over time, we could see the attention shifting to the large U.S. debt load – and investors demanding more compensation for holding long-term government bonds.

Debt dilemma

The U.S. debt ceiling deal has taken the near-term risk of default off the table. Yet the fiscal situation remains challenging, in our view. Total public debt as a share of GDP has jumped to around double the level in 2005 (left chart). The budget deficit is also already large (right chart) at a time when the economy is overheating. The debt deal doesn’t really change this picture, we think. The spending cuts are a fraction of what was cut in the last debt ceiling showdown in 2011: about 0.3% of GDP, according to the Congressional Budget Office, compared with 1% in 2011. We don’t see spending cuts dragging on growth in the same way as a result. But we do think higher-for-longer interest rates will raise debt servicing costs and could leave debt levels growing in this new macro regime. We have said the market focus would move back to the macro picture after the debt ceiling deal – now the Federal Reserve and stubborn inflation are retaking the spotlight.