Sometimes the world seems downright unhinged. The atrocities in Israel are just the latest reminder that all is not well with the human condition. From a purely financial perspective, though, the situation in the Middle East should have little impact on the global economy, at least as long as it remains mostly confined to Israel and the surrounding territories.
Meanwhile, a November 22nd budget deadline approaches and our dysfunctional Congress seems barely able to keep the government operating. And with all of the debt we have racked up over the years, nearly $8 trillion in the last three years alone, not to mention the trillions of dollars we plan to add to it in the years to come, we need the government to continue operating. If for no other reason, than this; eventually all of our debt has to be refinanced. When an investor buys a US Treasury bond, the US government has to eventually pay that investor back. But where does that money come from?
Given our existing obligations – Social Security, Medicare, and the military, to name the big ones, in addition to interest expense and myriad other smaller expenditures – there is little chance at this point that we will ever run a budget surplus and have the excess cash flow to repay our debts that way, which means we have to issue new bonds every time the old ones come due. And with interest rates at 16-year highs, new bonds are going to cost us a lot more than those issued in the previous 15 years. So, with interest expenses already set to increase dramatically (by more than double at today’s rates), we should be very careful not to jeopardize the United States’ reputation as a “safe haven”, as that could make it harder to issue new bonds in the future, possibly forcing us to offer bonds at even higher interest rates, eventually resulting in higher taxes and/or deeper budget cuts.
The outlook on the economy remains murky. We seem to have avoided a recession this year, but many economists and investment strategists are still predicting one next year. The general consensus is that any recession will be a shallow one. Raymond James’ Chief Investment Officer, Larry Adam, estimates that “the US economy will have a mild recession in the first part of 2024 before rebounding in the second half. ” Similarly, JP Morgan’s Chief Global Strategist sees the slowdown being a “swamp, not a cliff.”
For now, market-watchers remain fixated on the Federal Reserve, as those short-term interest rates have the potential to affect both stock and bond prices, as well as the broader economy, and could be a factor in the severity of the recession, should one occur. Inflation has been trending down, but the Consumer Price Index is still 3.7% and the central bank seems committed to their 2% target. The Fed did not raise rates at their September meeting, citing “the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” But they also said “We are prepared to raise rates further if appropriate, and we intend to hold policy at a restrictive level until we’re confident that inflation is moving down sustainably toward our objective.”
Bond traders may finally be conceding to the Fed’s insistence that they will keep interest rates higher than the market expects for longer than the market expects. Longer-term bond rates had remained stubbornly low until recently, but in the past quarter they finally moved closer to parity with short-term rates. Yet even still, the yield curve remains inverted, as it has since July 2022, with short-term rates higher than longer-term rates. Such anomalies rarely last for more than a year, and have never lasted more than 21 months. For the curve to normalize, one of two things has to happen; either short-term rates have to fall, as they likely would during a recession, or longer rates have to rise even further. Bond traders, along with most economists and market strategists, still seem to be betting on the former, in spite of the Fed’s official interest rate estimate of 5.1% for 2024.
The stock market has been soft the last several months as well. Perhaps this is just a normal correction after a strong start to the year. Or maybe stocks are finally starting to price in the much-anticipated and long-awaited recession. We will have to wait and see how that impacts the typical year-end rally.
The information above represents the opinion of financial advisor Travis Rus, and is not necessarily that of Raymond James. It is not a complete summary of all available data necessary for making an investment decision and does not constitute a recommendation, nor is it a complete description of the securities, markets, or developments referred to herein. Opinions are subject to change without notice. Information has been obtained from sources considered reliable, but we cannot guarantee that it is accurate or complete. Investing involves risk and you may incur a profit or a loss. Past performance does not guarantee future results.
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