5th May 2023
A Holiday from Banks?
Higher interest rates and investor concerns have triggered a forced takeover of First Republic by JP Morgan Chase last weekend, and a sharp fall in share prices of other regional banks. The US could do with a holiday from banks. Unlike in the UK, which has a very small number of large banks, the US continues to operate a large number of small, regionally based banks. These smaller banks, which remain under the radar (until they go under) provide much of the lending to commercial real estate in the US and smaller private companies. Banking issues have yet to show up in US economic data, but with the pace of growth already moderating, turbulence is likely to slow growth further, as well as unwittingly ease inflationary pressures. The likely result being the Federal Reserve halting further interest rate increases. Every cloud has a silver lining?
The most recent US interest rate rise took place on Wednesday, but with a change of tone in the associated statement. The Federal Reserve had suggested that they would continue to raise rates through the rest of 2023. But even as inflation remains elevated, they now suggest that US rates are close to a peak. Investors certainly think so, with rate cuts priced in for the end of 2023.
Debt ceiling to raise the roof on risk?
The US debt ceiling is the maximum amount of money that the US government can borrow. It was put in place to apply fiscal constraint on the President. The current ceiling is $31.4 trillion. The US Congress can choose to lift the debt ceiling, temporarily suspend it, or allow Treasury to go above the debt limit for a certain period of time. Since 1960, Congress has raised, temporarily extended or revised the debt limit 78 times. This occurred 49 times under Republican presidents and 29 times under Democratic presidents. However, in 1995 the Republicans in Congress and President Clinton couldn’t agree to a budget or an increase in the debt ceiling leading to a shutdown of US government. President Obama faced similar problems. In 2011 this led to the Standard and Poor’s credit agency downgrading the US debt from AAA. 2013 saw a 16-day shut down.
The US Treasury Secretary Janet Yellen (who used to be the Chair of the Federal Reserve) wrote earlier this week that the US Treasury could run out of money by the 1st of June as the current debt ceiling is likely to be breached. The Republican controlled House of Representatives appears to be at a stalemate with President Biden. Republicans are proposing cutting public spending before agreeing to a $1.5 trillion ceiling increase. Without agreement, the US government will need to stop spending.
Investors shouldn’t panic. The 2011 experience saw the US Treasury continue to pay interest on its debt. Looking ahead, as old debt matures it would be refinanced by the sales of new debt, without increasing the overall level of debt to the US Government. To ensure that interest could be paid and debt levels not increase, then other government payments would have to be cut by around 25%. It would delay payments to social security beneficiaries and contractors. Federal workers could face a period of not being paid. Whilst the initial market impact is likely to be mild, the overall economic impact will be determined by the length of time before the debt ceiling is eventually increased, as it always has been in the past.
In the worst possible outcome, the US government could be prosecuted for paying interest costs whilst not meeting other legal obligations. If the US Treasury stops or delays payment of interest on its debt (i.e. technically default on its debt) this would be new ground and the market would be rightly concerned.
Long to reign over us
With the new King being crowned on Saturday, Artorius wish him and all of you a rainless weekend.
Gerard Lane Chief Investment Officer
All expressions of opinion reflect the judgment of Artorius at 5th May 2023 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance is not a reliable indicator of future results. Nothing in this document is intended to be, or should be construed as, regulated advice. Artorius provides this document in good faith and for information purposes only. Reliance should not be placed on the information contained within this document when taking individual investments or strategic decisions. Artorius Wealth Management Limited is authorised and regulated by the Financial Conduct Authority. Artorius is a trading name of Artorius Wealth Management Limited.