Markets are quiet, a little too quiet

24 May 2023

Mark Lister
An older lady enjoying the peace and quiet by the lake.

World sharemarkets have been remarkably calm in recent weeks, despite plenty of uncertainty around.

Inflation is still stubbornly high, nor is it completely clear how much further interest rates will rise. We’ve also got the small matter of the US debt ceiling to resolve.

Former Federal Reserve Chair and current Treasury Secretary, Janet Yellen, has said the country might be unable to pay all of its bills by June.

The US is the world’s largest economy and its more important borrower, so that’s kind of a big deal.

With that in mind, you’d think markets would been on edge, but that’s not the case.

The S&P 500 in the US, which hit a nine-month high last week, has rallied almost ten per cent this year.

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Meanwhile, volatility is at the lowest levels since July 2021, almost two years ago. It’s been a similar story for other global share and currency markets.

The US actually hit its debt ceiling back in January. Since then, it’s been using “extraordinary measures” to keep things running, but time is running out.

It sounds ominous, but raising the debt ceiling is a regular occurrence in the US.

Since 1917 there’s been a statutory limit on the amount of debt the Government is the allowed to have, and total debt has increased under every president since Herbert Hoover in the 1930s.

The economy has grown steadily over that period, while over time inflation also ensures these borrowing limits (which are set in dollar terms) must also be periodically increased.

That’s not to say the US isn’t a highly indebted nation. It is, and debt levels have rising steadily in recent decades.

However, this needs to be considered in relation to the size of the economy, rather than in dollar terms.

Anyway, the US debt ceiling has been increased 78 times since 1960.

In recent decades it’s become an increasingly political issue, as the major parties use it to try and gain leverage over each other.

That’s one reason markets have been relatively relaxed of late. The brinkmanship is expected these days, and investors have grown accustomed to eleventh hour agreements.

However, taking it lightly hasn’t always paid off.

Examples of debt ceiling negotiations turning pear-shaped include 1995 during Bill Clinton’s first term, then in 2011 and 2013 under Barrack Obama.

While it was eventually resolved in all of those examples, there was significant disruption as government services were shut down temporarily and financial market volatility ensued.

The 2011 episode even resulted in the US losing its prized AAA credit rating, which it hasn’t regained.

Some analysts have compared that period to today.

The US sharemarket went similarly sideways in the lead-up to the deadline 12 year ago, hopeful an agreement would be reached well in advance.

It wasn’t, US shares fell 18 per cent in the following two months, before recouping those losses early the following year.

During that period the local sharemarket declined six per cent, the NZ dollar slumped 14 per cent, and oil prices tumbled 24 per cent.

Investors flocked to safe haven assets, with the US 10-year Treasury yield falling from 3.0 per cent to 1.8 per cent and gold prices surging 20 per cent to over US$1900 per ounce.

Gold quickly fell back to earth in the weeks that followed, and it didn’t reach those heady levels again until the pandemic in 2020.

Back in the present day, there are other reasons US investors are in good spirits at the moment.

A solid quarterly earnings season has just finished, inflation is headed lower, and it looks like the Federal Reserve might have increased interest rates for the last time.

If the debt ceiling debate is resolved without fanfare, this could add to the positive sentiment.

However, there isn’t much room (or time) error, and the calm will quickly turn to turbulence quickly if the politicians misjudge the situation.

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Mark Lister

Mark Lister

Investment Director
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Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.

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