The US debt is approaching its limit again, will the volatility of US stocks intensify?
In 2011, the United States faced a similar deadlock. At that time, the European debt crisis was in full swing, policy interest rates were close to zero, there was a risk of deflation in the market, and the size of the Federal Reserve's balance sheet expanded.
Source: BlackRock
Negotiations to raise the US debt ceiling are heating up. The US Treasury hit the debt ceiling in January this year, and as we approach June, the Treasury may not be able to pay government debt on time. Even if an agreement is reached before then, we expect the debt approaching the ceiling to exacerbate market volatility.
The US faced a similar deadlock in 2011. At that time, the European debt crisis was in full swing, policy rates were close to zero, and there was a risk of deflation in the market, leading to an expansion of the Fed's balance sheet.
However, the situation today is very different, with US bond market volatility exceeding 2011 levels (orange line), as the market grapples with the difficult balance between the Fed's coexistence with inflation or suppression of economic activity.
The volatility of the US stock market is relatively mild (yellow line), but we believe that US stocks will not be spared. Looking at the performance of the S&P 500 index, only a small number of technology companies have driven profits so far this year.
In the new pattern, financial market volatility has become the norm, and the approaching debt ceiling will exacerbate this trend. If the prices of risk assets can reflect expectations of economic recession, we will change our cautious view for the next six months to a year and maintain a flexible attitude to seize investment opportunities.
In the short term, we are underweighting developed market stocks, while optimistic about the performance of emerging market stocks, as they benefit from the restart of the Chinese economy, the end of the emerging market central bank interest rate hike cycle, and the generally low US dollar exchange rate. If the approaching US debt ceiling triggers market volatility and economic recession leads to a sharp drop in stock prices, we may consider overweighting stocks as a whole.
If US Treasury yields continue to rise, opportunities in short-term bonds can be considered. If investors are not in a hurry to sell, they can consider holding US Treasuries until maturity during the US debt ceiling negotiation period. At the same time, the sustained high inflation also makes inflation-linked bonds attractive investments.
