“Once the debt crisis is behind us, the focus is likely to shift back to the Federal Reserve,” Daleep Singh, chief global economist for PGIM Fixed Income, said in an interview. The Fed has been raising interest rates in its fight against inflation since March 2022 and must decide what to do at its next meeting in June. “The Fed faces a trio of risks,” he said. These include:
-
The potential for economic drag from the more restrictive fiscal policies that House Republicans are demanding from President Biden as a condition of raising the debt ceiling.
-
The delayed effects of the Fed’s restrictive monetary policy. Is a recession coming? Has inflation been overcome? Should the Fed raise rates further, keep them where they are, or start lowering them to avoid a recession?
-
The possibility of renewed flare-ups in the banking system. Regional banks like Silicon Valley Bank and Signature Bank have been bailed out by regulators, First Republic has been acquired by JPMorgan Chase, and banks like PacWest, Western Alliance, Comerica and Zions Bancorp have come under pressure. Bank runs and losses on long-term investment, exacerbated by the Fed’s policy of raising rates, could resume if the Fed holds rates at current levels or raises them further.
Curiously, the debt-ceiling crisis provided temporary relief for many of the country’s banks, economists at Moody’s Investor Service found in a recent study. “The debt ceiling impasse is a tailwind for the banks,” Jill Cetina, associate managing director of Moody’s, said in an interview.
But once the debt ceiling is lifted and the Treasury starts raising money by selling large amounts of bonds, those purchases by investors on the open market will drain money from banks. “This may not be what you would expect, but the resolution of the debt ceiling crisis will be a headwind for banks,” she said.
Global tensions remain high. The Russian war in Ukraine continues, at a staggering cost. Russia and China, its supporter, if not formal ally, are nuclear powers, and with NATO countries pouring increasingly deadly military aid to Ukraine, the threat of a tragic escalation of the conflict cannot be entirely dismissed. From a purely economic point of view, while energy prices have fallen sharply from their peaks at the start of the war in Ukraine, the possibility of further unexpected shocks remains. US-China relations are fraught and global trade relations are fraying.
In addition, while the emergency phase of the pandemic has ended in the United States and many other countries, the coronavirus is still with us and continues to take a heavy toll in death and suffering. In the week of May 4 alone, 840 people died from the virus in the United States, bringing the steadily rising death toll to 1,133,684. Thousands of people suffer from the long-term effects of the disease.
In an economic sense, the effects of Covid-19 are also still with us. The expansionary fiscal and monetary policies introduced to combat the Covid-induced recession in 2020 have been remarkably successful in restoring economic growth. But the inflation that has spread across global economies over the past two years is also partly a result of those policies and the supply shocks caused by the virus. Even if the coronavirus doesn’t break out again in the United States, the economy and markets are still adjusting, putting the Federal Reserve in a dilemma, and countries like China continue to experience severe outbreaks.
