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Markets up on worsening economic data.

Local and global stock markets rose this week on the back of weaker economic data.

Australian employment unexpectedly fell in April with 4,300 fewer people employed versus March. The fall saw the unemployment rate tick up to 3.7% with an additional 18,400 unemployed.

The minutes of the RBA’s May meeting show that the decision to raise by 0.25% was a close one, but concerns surrounding strong services inflation pushed the call over the line.

Eurozone industrial production fell by 4.1% in March, coming in well below expectations and the biggest fall since April 2020. The largest contractions came from Ireland and Germany.

The European Union raised its inflation forecasts to 5.8% this year and members expect the European central bank to continue with rate hikes.

Japan’s economy emerged from recession and grew faster than expected in the first quarter as post-covid consumption rebounded strongly.

US President Biden cancelled his trip to Australia for the Quad meeting and shortened his G7 trip to Asia to focus on resolving the US debt ceiling debacle which remains ongoing. Estimates have the US government running out of money to meet expenses as early as 1 June.

Top of Mind: Debt Ceiling in Focus

The latest concern and risk that investors are having to contend with is the prospect of the United States defaulting on trillions of dollars’ worth of loans. That is unless the Republicans and Democrats strike a deal to legally allow the US Department of Treasury borrow more though debt to allow it to pay its bills.

The amount of debt that the US can incur is known as the debt ceiling and the “X date” is the date at which the US will hit that limit. While the exact date for the “X date” is hard to predict, Treasury Secretary Janet Yellen has indicated the government will fall short of funds by mid-June. 

Thankfully over the weekend, debt ceiling talks that had stalled were back on with Joe Biden and Kevin McCarthy agreeing to resume negotiations to avoid the US defaulting. This came a day after they broke off talks! 

If Democrats and Republicans do not agree to allow the US to raise the debt ceiling - the world's biggest economy will default on its $31.4 trillion (£25tn) debt. If the US does not lift its debt ceiling, it will not be able to borrow more money - and it will quickly run out of funds to pay for public benefits and other obligations.

The White House Council of Economic Advisers estimates that if the government cannot reach a debt ceiling agreement for a prolonged period, the economy could shrink by as much as 6.1% which would most likely tip the US into the recession that it is heading towards. That would have big knock-on effects for the rest of the world, many of which count the US as a key trading partner.

In addition, the US dollar is the reserve currency of the world. Should the US government default, the value of the dollar is expected to drop sharply with knock on effects for commodities and commodity orientated economies such as Australia.

It could also exacerbate the inflationary problems we have already been facing. With a weakening US dollar, everything would need to be repriced. That could lead to food and fuel becoming more expensive and would again raise the cost of living for millions of people.

The stock market is also likely to react badly to a US default as it erodes confidence in the world’s largest developed market economy. We don’t think that will be the case though. If history is a guide, you would expect a resolution to be met. Although, it wouldn’t be surprising to see it left to the last minute and create a lot of volatility across markets. That is what we saw in 2011 when the Democrats and Republicans remained at an impasse over the debt ceiling until hours before a potential default. US stock markets plunged but it was short-lived, and shares recovered from the sharp fall once details of the deal became known. We think we are likely to see the same again this time round.