Is US economic data running hot at the same time as the US is running out of cash?

As we move through this week there are a couple of key themes that are dominating market sentiment. Firstly, the slow uptick in economic data in the US– surely something that the Federal Reserve doesn’t want to see as it mulls pausing interest rate hikes. Secondly, fears about the future of the US’s debt ceiling. Will Congress bash their heads together and come up with a solution before the US Federal government runs out of money, or will it go to the wire, or even over the edge? Obviously, the latter is the worst outcome, however the financial markets are not quite in the headspace for this, in our view. Thus, US economic data and what the Fed does next is still the driving force across markets. .

Retail sales boost the chances of soft economic landing for the US

The economic data in the US may not be playing ball with the Federal Reserve and data for April and May is painting a confusing picture. Consumer confidence fell off a cliff in the US, and long run inflation expectations rose to their highest level in 12 years according to the latest University of Michigan survey data. Yet, retail sales bounced back strongly last month, rising 0.7% on the month for the control group, and the ex-autos figure was also up 0.4%. Sales were 1.2% higher than last year. Food services saw a large upswing, rising 9.4% from last year and non-store sales also jumped by a decent 8% on the year. It is worth noting that these figures do not adjust for inflation, however, headline price growth fell below 5% in April, while core prices rose by a monthly 0.4% last month. Due to this, we can assume that US consumers seemed happy to spend at a higher rate than in March, even if they knew that more Fed rate rises were coming down the line – the Federal Reserve hiked interest rates on 4th May for the tenth consecutive time.

US economy shows broad based strength

The interesting thing about US data right now is that the consumer isn’t the only part of the economy to show signs of strength, industrial production also rose at a 0.5% monthly rate in April, the highest monthly gain since July last year. Business inventories dropped 0.1%, which could spur more activity down the line, and even the beleaguered housing market is showing signs of picking up. The NAHB housing market index rose to 50 in May, up from 45 in April, this is the highest reading since August 2022. Thus, we expect the economic surprise index for the US to tick higher for this week. All of this data is inconsistent with an economic slowdown in the US in the coming months, but, what does this mean for the market?

Rising expectations of further rate hikes from the Fed

Firstly, we need to look closely at what this means for the Federal Reserve. One thing that we have noticed is that there is a growing probability that the Fed will now hike by 25 basis points at its next meeting in June. There is currently a 22% probability attached to the chance of a rate hike to 5.25-5.5% at the next FOMC meeting, which is higher than the 15% chance expected last week, and the 8% chance at the start of May. If expectations for further rate increases continue to rise, then we could see a break to the downside for stocks that are currently hovering in a frustrating range. The S&P 500 has traded between 4025 and 4168 since 25thApril, it is currently trading at approximately 4129, after a relatively lacklustre week for the US blue chip index.

The dollar: a harbour in the debt ceiling storm

Growing expectations that the Fed is not done with hiking rates is helping to boost the dollar. The greenback is one of the best performing currencies in the G10 FX space on Wednesday, and EUR/USD is falling sharply back towards 1.08 after trading above 1.10 at the start of this month. EUR/USD, which had been riding high in Q1, has lost more than 1.5% in the past month, as the dollar has gained traction. GBP/USD has fared better, as it up some 0.4% in the past month, although it is down 1.23% this week and is currently below $1.25 – a key resistance zone for this pair. In fact, in the coming days and weeks we could see the perfect storm for further dollar gains: stronger economic data, a Fed desperate to roll back expectations that it won’t hike rates again and a US debt crisis. The latter will likely boost the dollar’s credentials as a haven, which could trigger further upside as we approach the 1st of June deadline, when the Treasury assumes that the US won’t be able to pay its bills. The balance in the US Treasury’s checking account was $87bn at EOD Monday, which is well below the Government’s targeted year-end balance of $600bn. The Treasury has said that it will continue to make payments including social security, military salaries, and interest on debt, and it also expects more tax receipts to come in over the next couple of days. However, this is enough to unsettle the US bond market: the spread between the 1-month Treasury bill yield and the and 2-year Treasury yield, is unusually wide, as investors shun ultra short term US debt. The 1-month yield has risen sharply, as prices fell, and it is now trading at 5.34%, whereas 2-year yields are 4.26%, .. This highlights how warped Treasury trading has become during this crisis. However, in the long-term things should be ok, and this is exemplified in the stability of the 10-year yield, which has been range bound since early March.

A boost for the oil price

Elsewhere, signs of a resurgent US economy that can withstand Fed rate hikes is boosting sentiment towards oil. The International Energy Agency is bullish on oil demand. It expects oil consumption to grow to 2.2mn barrels per day, demand could reach 102mn barrels per day and demand could exceed supply in the second half of the year. The Brent crude oil price is up more than 1.5%, driven by this news. There could be further upside to go, Brent was trading at $86 per barrel in mid – April, so there is room for moire upside in the coming weeks. This would pose another headache for the central bankers as it could make it harder to keep the lid on headline price growth.