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Latest Update: U.S. Debt Deal Shifts Wall Street’s Focus to New Risks
In a surprising move, a last-minute agreement has been reached to increase the U.S. debt ceiling by a massive $31.4 trillion. This decision is expected to redirect the attention of Wall Street towards other potential dangers. These risks include the possibility of more interest rate hikes by the Federal Reserve and a predicted decrease in government spending.
During their meeting on May 3, the Federal Reserve hinted that they might pause their aggressive cycle of raising interest rates, which hasn’t been seen since the early 1980s. This news prompted investors to jump back into riskier assets like stocks. As a result, the S&P 500 index has risen by over 9.4% this year and is now trading at nearly 19 times its projected earnings, at the higher end of its historical range.
However, experts have expressed concerns about the current situation. They believe that there may be limited room for further growth. Dallas Federal Reserve Bank President Lorie Logan and St. Louis Fed President James Bullard have noted that inflation doesn’t seem to be slowing down quickly enough. Strong economic data has further supported their position, with core inflation reaching 4.7% in May, well above the Fed’s 2% target.
Market expectations now suggest a 50-50 chance of a 25 basis point interest rate increase at the June 14 Federal Reserve meeting, compared to an 8.3% probability just a month ago. Additionally, a congressional package to raise the debt ceiling is likely to impose spending limits on government programs.
This combination of factors, including potential rate hikes and reduced spending, may have negative consequences for the U.S. economy. It could even push it into a recession, despite the current strength of the labor market.
Despite initial optimism, investors are realizing that economic strength might lead to higher inflation, prompting further rate hikes. This presents a difficult scenario, as either scenario could negatively impact stock multiples or indicate an economic downturn.
The recent debt ceiling dilemma has weighed on stock market performance, although most investors anticipated a resolution. Consequently, a sustained relief rally is unlikely. Furthermore, the equity market has only just begun to factor in the possibility of more rate hikes.
In the coming months, companies that issued debt during the pandemic, taking advantage of low interest rates, will face challenges. With higher rates on the horizon, they will need to either pay off or refinance their debt. Approximately $6.5 trillion issued between 2020 and 2021 will mature by 2025, leading to concerns about the long-term effects of current monetary policies.
It’s crucial to pay attention to these under-discussed issues surrounding the mounting debt and its impact on the economy, cautioned experts.