Q2 2023 Quarterly Market Outlook

Market Outlook Key Takeaways

US Debt Limit Impasse

Debates over federal fiscal policy and rising debt levels have resulted in contentious debt limit episodes in recent years. The current U.S. debt ceiling is set at $31.4 trillion, last raised in December 2021. However, a debt limit standoff is once again imminent. 

Although extraordinary measures are being used to allow the government to continue borrowing, Treasury Secretary Janet Yellen has warned that the "X Date," when the Treasury's ability to finance government operations ends, could occur as early as June 1, 2023. While there is uncertainty around the debt ceiling, we believe that the probability of a default on Treasury debt obligations is very low.

Nevertheless, we acknowledge the risks associated with debt ceiling episodes and consider them in portfolio strategies. We have formed a task force to analyze market conditions and historical precedents to determine the best approach for clients. We are closely monitoring the situation and manage their exposures conservatively, keeping clients informed.

Treasury Bill Market Impact

Past debt ceiling episodes have primarily affected the U.S. Treasury Bill market, with investors showing aversion to maturities vulnerable to delayed payment risks. This aversion has intensified with the accelerated timeline for resolving the debt limit issue. We suggest that a larger government money market fund footprint and a restrictive balance sheet environment for banks and broker/dealers could further increase aversion to vulnerable obligations.

Treasury Issuance

Regarding U.S. Treasury issuance, net T-bill issuance typically decreases leading up to debt ceiling dates to comply with borrowing limits and accommodate Treasury coupon settlements. Similarly, current net T-bill issuance has declined monthly since January, with a significant contraction in April. However, once the debt ceiling is resolved, we expect a substantial increase in T-bill supply, which could provide relief to current rates.

Potential Ratings Downgrades

There are also concerns about potential ratings downgrades. Major ratings agencies have warned that a default triggered by a missed debt payment would lead to a downgrade of the U.S. sovereign and all Treasury security ratings. Moody's considers any missed payment a default, while Fitch Ratings believes that reaching the X-date without raising the debt ceiling would have negative implications for the U.S. sovereign rating.

In conclusion, the U.S. is facing another debt limit standoff, which could result in a funding crisis if Congress doesn't raise or suspend the debt ceiling by June. While the situation may be unnerving for investors, we believe that a default on Treasury debt obligations is unlikely. However, they still consider the risks associated with debt ceiling episodes in portfolio strategies and closely monitor the situation. The debt ceiling issue has historically affected the Treasury Bill market, and there may be implications for Treasury issuance and potential ratings downgrades if a resolution is not reached.

Federal Reserve Pauses Interest Rate Hikes

The Federal Reserve's recent rate hike is likely to be the last one in the current cycle, according to market expectations. Several factors support the idea of a pause in rate increases. First, economic growth has slowed, and inflation has moderated, although it remains above the Fed's 2% target. Second, policy rates have reached levels consistent with the Federal Reserve's guidance. The recent 25 basis point hike brings the policy rate range to 5.00–5.25%, aligning with the Fed's projections. Lastly, stress in the banking system has tightened financial conditions, potentially eliminating the need for further rate hikes.
A Fed pause does not indicate a complete change in direction but rather a period of monitoring the economy and inflation while keeping rates at their current levels. Historical data from previous hiking cycles suggests that the pause could last around 10 months before the Fed considers cutting rates. The current tightening cycle has been faster than usual, but it is expected that the pause will align more closely with historical averages.
Investors who have been holding cash or cash alternatives may want to reconsider their allocations as the Fed hiking cycle potentially comes to an end. While cash provides safety during market volatility, it tends to underperform compared to core bond and short-term bond exposures when the Fed stops raising rates. Data from previous periods show that core bond exposures have performed 4% better than cash on average, while investment-grade short-term bonds have performed 1.9% better.
As the U.S. economy shows signs of slowing activity, investors may consider adding high-quality medium-term fixed income assets to their portfolios. Bonds maturing between 3–7 years in the broader U.S. bond market can provide stability, and even if bond yields rise, current yields offer potential positive returns. Additionally, emphasizing quality in stock portfolios can be beneficial during a pause period, as rates are expected to remain relatively firm. Growth companies with strong quality characteristics, such as high returns on capital and solid balance sheets, have tended to outperform in late-cycle environments with tight financial conditions.
Considering the current market conditions, it is expected that the equity markets will remain range-bound, and potential upside may be limited. Defensive strategies like minimum volatility can help lower risk in portfolios and allow investors to stay invested during market turmoil. These strategies have historically shown approximately 18% less volatility than the S&P 500 Index.
While past performance does not guarantee future results, historically, both domestic equity and fixed income markets have posted higher returns three months after the Fed's last rate hike.

What This Signals Going Forward

More volatility ahead

We think the U.S. debt limit showdown will spark renewed volatility in markets. That risk reinforces why we stay invested and maintain quality investments.

Market backdrop

Stocks were flat last week after U.S. data confirmed core inflation staying high. We think sticky inflation makes Federal Reserve rate cuts later this year unlikely.


Any reference to an index is included for illustrative purposes only, as an index is not a security in which an investment can be made.  They are unmanaged vehicles that serve as market indicators and do not account for the deduction of management fees and/or transaction costs generally associated with investable products. The holdings and performance of client accounts may vary widely from those of the presented indices. S&P 500 Index is a market capitalization weighted index which represents the broad market for large company U.S. stocks. . The EAFE Index is a stock index offered by MSCI that covers non-U.S. and Canadian equity markets. It serves as a performance benchmark for the major international equity markets as represented by 21 major MSCI indices from Europe, Australasia, and the Middle East. The MSCI Emerging Market Index captures large and midcap representation across 24 emerging market countries. The Bloomberg Dollar Spot Index (BBDXY) tracks the performance of a basket of 10 global currencies against the U.S. dollar The Bloomberg Aggregate Bond Index broadly tracks the performance of the U.S. investment-grade bond market and is composed of investment-grade government and corporate bonds.

This material presented by MA Private Wealth (“MAPW”) is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product.  Facts presented have been obtained from sources believed to be reliable, however MAPW cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source.  MAPW does not provide legal or tax advice, and nothing contained in these materials should be taken as legal or tax advice. This information may contain certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those discussed. No investor should assume future performance will be profitable or equal the previous reflected performance. MAPW may change its positions regarding the investment discussed herein and possibly increase, reduce, dispose of, hedge, or change the securities without notice. Past performance does not guarantee future results.  Consult your financial professional before making any investment decision. 

Topics: market commentary

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