Our Top Market Takeaways for January 20, 2023

Market update: When bad news isn’t good news

Stocks sank and bonds rallied as soft landing hopes gave way to recession fears.
Heading into Friday, the S&P 500 and tech-heavy Nasdaq were down more than -2%, while 10-year U.S. Treasury yields have now fallen -45 basis points just in the first three weeks of the year. That said, stocks outside the U.S. continued to hold their ground –both Europe and China were flat to slightly higher on the week.

The culprits:

• Slowing growth. Despite last week’s optimism around decelerating inflation, investors seem spooked that growth is becoming scarcer. Retail sales fell by more than expected as consumers feel the pinch and factory output showed the weakest quarter for manufacturing since the start of the pandemic.
• Fed hawkishness. The Fed doesn’t seem swayed by the latest data, even if it’s moving their way. A host of Fed speakers this week signaled their intention to keep hiking. In their mind, while a slowdown in the pace of hikes might be warranted, the job isn’t done: Inflation is still too high, and even as growth slows, the labor market remains too tight (new applications for unemployment benefits are at their lowest since September).
• Cautious word from corporates. So far, Q4 earnings season has been better than expected—but that is off a low bar (it’s expected to be the weakest for the S&P 500 since 2020). The cautious commentary coming from management teams has been hard to ignore. Moreover, job cuts in tech continued this week as Microsoft and Alphabet both announced more layoffs.

But we’d be remiss not to mention there were a few bright spots:

• Producers are seeing lower prices on their products, in a sign that goods inflation continues to decelerate. The producer price index fell -0.5% in December, down from +0.3% in November.
• Mortgage rates have fallen 1% from their peak (for 30-year fixed, to 6.37% from 7.35%), catalyzing the largest weekly jump in applications since 2020. Housing starts for single-family homes also saw their first gain in four months.

We’re at a pivot point, and markets are trying to work out the path forward. And if the state of the economy didn’t bring enough to digest, political conflict around the debt ceiling is also unfolding in Washington – with much at risk. Below, we answer 5 questions on what could be a messy government showdown.

Your questions, our answers: Debt ceiling drama

The U.S. government hit its legal $31.4 trillion debt limit yesterday. From here, the Treasury (which runs the government’s pocketbook) is expected to run down its cash balance and use “extraordinary measures” as long as it feasibly can to help the government continue to pay its obligations. But those measures won’t last forever – by our estimates, the runway should last until at least June – and Congress is faced with overcoming political gridlock to address the ceiling before the clock runs out.

The punchline:

We will likely see heightened market volatility around these deadlines this year, but if history is any guide, we expect policymakers to eventually find compromise and the impact to be short-lived. The key is to focus on your long-term investment plan.

1. What’s the debt limit? How does this all work?

Everyone has bills to pay, including the U.S. government. To meet its obligations (which include paying military salaries, retiree benefits, interest on national debt, etc.), the Treasury sells bonds (i.e., issues new debt) to investors across the globe. Because the U.S. government consistently runs a budget deficit (meaning it spends more than it takes in), the Treasury issues even more debt to pay its outstanding obligations and as a result, the stock of national debt has continued to rise.

But the so-called debt limit designates the maximum amount the U.S. government can ultimately borrow. Today, that limit stands at $31.4 trillion. Some form of a debt cap has been in place since 1917, and since WWII, the ceiling has been raised or suspended 102 times – the last time being 2021.

2. What happens next?

Now that we hit the limit, the Treasury will run down its cash balance at the Fed and use “extraordinary measures” to keep expenditures flowing (through fancy accounting that limits some government investments and reduces the amount of debt subject to the limit). That runway is broadly estimated to last until at least June, but there is a lot of uncertainty around that date.

Congress is in charge of suspending or raising the limit, and the next few months will likely see members from both political parties demand concessions as they try to negotiate a deal.

3. But what if the government can’t get it done?

If Congress does not suspend or raise the limit, the risk of default becomes a reality. We would expect the Treasury to prioritize paying its debt obligations, while curbing its discretionary expenditures (like education or transportation). The impact could be economically calamitous (through a potential global recession) and disruptive for investors (for instance, through persistently higher Treasury borrowing costs).

That said, history is on our side that policymakers will find consensus to avoid a worst-case scenario of default.

4. What have markets done in past episodes of debt ceiling drama?

The closest call in recent past was 2011, when Congress increased the ceiling just 2 days before the Treasury was expected to exhaust its efforts. Days later, Standard & Poor’s downgraded the U.S. credit rating to AA+ (from AAA). Risk assets reacted negatively: the dollar sold off, stocks sank, and credit spreads widened, but a strong rally in Treasuries (driven by other percolating market fears at the time like the European sovereign debt crisis) led bonds higher overall.

Outside of 2011, other recent instances have seen markets more driven by the prevailing economic and market dynamics of the time, and any volatility around debt ceiling drama was ultimately short-lived.

Policymakers eventually found compromise in all of these instances.

5. Can I do anything to prepare for a disorderly episode?

Diversification is the best defense. The potential for a disorderly debt ceiling episode adds just another kicker for global investors to rebalance U.S. overweights across asset classes – a key point expressed in our 2023 Outlook.

For instance, consider currencies and precious metals like the Japanese yen, the Swiss franc, and gold. Further, yields globally have risen, with bonds outside of the U.S. also now providing compelling income and protection. Finally, while stocks globally could take a hit in a disorderly episode, high quality international equities (which are already catching a bid from China’s reopening, Europe’s improving energy dynamics, and higher exposure to the real economy) could provide relative insulation.

All in all, this isn’t the first time a debt ceiling episode has caused drama for investors, and it probably won’t be the last. Through the noise, we think it’s best to stick with your long-term investment plan.

DISCLOSURES

All market and economic data as of January 20, 2023 and sourced from Bloomberg and FactSet unless otherwise stated.

The Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases.

The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.

Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk.  Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.

The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to 'stock market risk' meaning that stock prices in general may decline over short or extended periods of time

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

RISK CONSIDERATIONS

• Past performance is not indicative of future results. You may not invest directly in an index.
• The prices and rates of return are indicative, as they may vary over time based on market conditions.
• Additional risk considerations exist for all strategies.
• The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
• Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.

IMPORTANT INFORMATION

All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.

Bonds are subject to interest rate risk, credit and default risk of the issuer. Bond prices generally fall when interest rates rise.​ Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss. ​