In what has become as much of an American tradition as the Superbowl, the White House and Congress are currently wrangling about whether they should allow the US government to borrow more money. The US has been operating on an annual deficit for most years since 2001 and now – once again – needs to get an increase in its debt limit to be approved by Congress in order to avoid a default.
That gives Congress, which is currently under Republican control, an opportunity to wring concessions from the Democrat executive about spending priorities. If they don’t come to an agreement about whether to raise the debt ceiling, the US could default on its $31.4 trillion debt. That would, in turn, have catastrophic consequences for the American and global economies.
The US government would soon find itself unable to pay civil servants or welfare benefits. If such a crisis had to stretch on for too long, the US economy would plunge into recession, dragging the rest of the world along with it. And the loss of confidence in the world’s leading economy and its reserve currency could trigger inflation and higher interest rates around the world.
A debt default is uncharted territory with ominous implications. However, robust stock market performance and US dollar strength this week show that the markets are reasonably confident about the prospect of a US debt default being unlikely.
Republicans are currently calling for deep spending cuts as a trade-off for raising the debt limit. But this game isn’t without precedent. We saw similar standoffs in 1995, 2011, 2013 and 2021. We believe that, as in the case in previous years, the debt ceiling will be raised before the US Treasury’s “X-date” of 1 June. Both sides are likely to make some concessions to get this done, or alternatively, an agreement may be reached, such as in 2021, that temporarily averts a default.
Historically, the US has raised its debt ceiling around 90 times since it was introduced in 1917!
Given that we see the risk of a US government debt default as relatively low, a more interesting question is what the consequences of raising the ceiling will be. Some analysts suggest that it will drain liquidity and lead to prolonged risk-off in equities markets—putting a soft landing for the markets and economy at risk.
However, the last time the debt default was averted in December 2021, the three major US stock market indices extended their recent gains.
“The debt ceiling historically has been among the best leverage that Congress has to rein in the executive.”
– Senator Ted Cruz, in Oct 2015
“To tie [the debt ceiling] to something about whether you break the promises of the United States government to people all over the world as well as its own citizens, just makes no sense. So, it ought to be banned as a weapon, it should be like nuclear bombs, basically too horrible to use.”
– Warren Buffett, an American business magnate and investor
Global News
- Debt-ceiling talks between White House and congressional aides are set to intensify as negotiators seek a framework agreement for President Joe Biden and House Speaker Kevin McCarthy to review upon the president’s return from a truncated trip to Asia. The latest round of talks from a White House meeting on Tuesday saw President Joe Biden and congressional leaders in both parties offering glimmers of hope about eventually reaching an agreement. McCarthy told reporters that the two sides were far apart but added that a deal by the end of the week to avert a default was possible. Wall Street believes that an agreement will be found, although this that doesn’t mean the economy will escape unscathed thanks to the standoff and Treasury’s efforts to return to business as usual once it can ramp up borrowing.
- Fed officials are currently divided over whether the Fed’s June 13-14 meeting will result in a hike or a pause in rates. A pause would normally signal that the next move would be a cut. However, another outcome being mooted is a “skip”, where a decision would simply be deferred to the July meeting. Chair Jerome Powell has an opportunity to provide more guidance when he speaks at a Fed conference in Washington later today. Dynasty’s most recent research on the rate curve has pointed towards rates not being increased at the next meeting.
- Based on corporate earnings, it is highly likely that a recession has already landed in the US. Wall Street is going through what could turn out to be the longest corporate profits downturn in seven years. The first quarter earnings season is ending, and the profits of S&P 500 companies are estimated to have dropped 3.7% on average year-on-year. Bearish earnings forecasts now center around the April to June period, for which a 7.3% profit slump is penciled in, according to data compiled by Bloomberg Intelligence. However, billionaire Paul Tudor Jones believes that stocks will end the year higher as he anticipates rate hikes coming to an end. In addition, the introduction of artificial intelligence will create a productivity boost only seen a few times in the last 75 years, which could add a 1.5% gain in output a year for the next five years. Agreeing with Tudor, JP Morgan believes interest rates will start coming down in the third quarter as the Fed will want to start incentivising economic growth.
- One of the key issues at the G7 meeting in Japan is likely to be the fight for global influence. China, Russia, the US and its allies will all increase efforts to win over governments in a deepening competition for hearts and minds in so-called middle ground countries, such as Brazil, Vietnam, South Africa and Kazakhstan. There could be the advent of a multipolar world compromising rival factions, as already seen in attitudes towards Russia’s invasion of Ukraine. G7 and European Union leaders are preparing to roll out plans to court a select group of nations in what they’re calling a global “battle of offers” with Beijing and Moscow, according to sources and documents seen by Bloomberg News.
- Economic recovery in the world’s second largest economy, China, is slowing as industrial output, retail sales and fixed investment grew at a much slower pace than expected in April. This is on the back of an initial burst in consumer and business activity early in the year. The slowdown has resulted in calls for more policy stimulus to bolster growth. A major concern was the jump in the unemployment rate for young people to a record high of 20.4%, nearly four times the national rate. This shows that the post-pandemic economy isn’t strong enough to absorb the millions of new entrants to the labour market. The rate is likely to increase when an estimated 11.58 million graduates are expected to enter the market.
- Joining the wealthy in exclusive countries requires millions. For example, to join the top 1% in Monaco, you will need $12.4 million to make the cut in the tiny Mediterranean principality, according to research from Knight Frank in its latest 2023 Wealth Report. Monaco is home to billionaire residents such as UK industrialist Jim Ratcliffe and Walgreens Boots Alliance chairman Stefano Pessina. Switzerland and Australia have the next highest entry points to join the wealth, requiring net worth of $6.6 million and $5.5 million, respectively. In the US, $5.1 million will get you over the threshold. These findings show just how the pandemic and surging living costs are widening the gap between rich and poor nations.
- The conflict in Ukraine is causing an increase in the price of coffee: From beans to instant coffee, the cost of this beverage is increasing due to a shortage of robusta beans, even as cash-strapped consumers seek ways to trim their spending. Robusta is usually less expensive than the premium Arabica beans. The situation is not likely to be resolved any time soon, as Vietnam — the world’s largest producer of robusta — is moving away from planting the beans. Farmers are focusing on planting more profitable crops like avocados and durians to cope with increasing fertilizer costs in the aftermath of Russia’s invasion of Ukraine.
- UBS Group expects an estimated $34.8 billion gain after its emergency takeover of Credit Suisse Group. However, it has sounded caution over the fact that it faces billions in potential legal and regulatory costs from the rescue of its stricken former rival. While it will benefit from negative goodwill, which is profit on paper and not real money, it sees mark-downs of about $13 billion on Credit Suisse assets and is also estimating that legal liabilities may cost as much as $4 billion over 12 months. These numbers could change.
- Global investment manager Ninety One wants to expand into the Middle East as it targets more growth after its assets under management declined 10% in the financial year to end-March. It had net outflows of £10.6 billion in the period under review, taking its assets under management to £129.3 billion. The company, which is battling with the current economic and political climate, has most of its assets by client group in Africa and the UK. Ninety One is backing its investment in North America to come good, while looking to grow in the Middle East.
- Vodafone Group is cutting jobs as it expects earnings this year to be flat. The cellular provider will cut 11 000 jobs, work to turn around its German business and start a “strategic review” in Spain. Earnings before interest, taxes, depreciation, and amortisation after leases are expected to be €13.3 billion in the year ending in March. Vodafone has been battling a lagging share price and has experienced difficulty consolidating its sprawling global operations. It will now focus on quality service and its business unit.
- CEO of San Francisco start-up OpenAI, Sam Altman, has testified before members of a Senate subcommittee on privacy, technology, and the law in terms of the effects of Artificial Intelligence. He mostly agreed with them on the need to regulate the technology, which is also being developed in companies such as Google, Facebook, and Microsoft. The tone of the hearing contrasted with previous antagonist hearings with tech executives such as Mark Zuckerberg, Jeff Bezos and other tech luminaries, who have all been dressed down by Capitol Hill by lawmakers upset with their companies. Top leaders in Congress have promised to table AI regulations.
- As at Thursday’s close the S&P was 1.8% up for the week.
Local News
- South Africa could well lose as much as R60 billion a year in exports to the US if it forfeits its privileged access to the US market under the African Growth and Opportunity Act (Agoa), because of its ever-closer ties with Russia. About half of that number is in motor vehicles – many of them high-end Mercedes-Benzes and BMWs – and about R8 billion in agricultural products, much of it citrus and wine. Jewelry is another major export.
- President Cyril Ramaphosa plans to visit Russia and Ukraine to meet his counterparts in the next two months as the Ukraine war continues to affect South Africa’s food security. Ramaphosa will be joined by six African heads of state who will discuss the “cessation of hostilities for the sake of human lives”, said an ANC national working committee member.
- South Africa’s army chief Lawrence Mbatha is in Moscow for talks with military officials and will visit military educational institutions, having been invited by his Russian counterpart for a meeting that was planned well in advance. Government has downplayed a report from Russia’s state-run Tass news service, which indicated that an army delegation is visiting Moscow for talks on enhancing military cooperation.
- After the Political Party Funding Act came into force in April 2021, the single biggest donor to the ANC has been United Manganese of Kalahari (UMK), an entity 25% owned by Russian oligarch Viktor Vekselberg, who is one of Russian President Vladimir Putin’s pocket oligarchs. UMK has donated a total of R30 million to the ANC. The donations were made over two years, which means UMK has reached its limit. R15 million is the maximum amount allowed by the legislation. Most of the rest of UMK is owned by the ANC’s commercial arm Chancellor House.
- Build One SA leader, Mmusi Maimane, argues that being pushed into a binary corner of choice by superpowers does not serve South Africa’s permanent interests. As a developing nation with under-development and rampant unemployment, trade and economic benefit are our interests. Old historical, nostalgic ties that don’t serve this interest belong to the past: “A new path is required, which has consensus not only with members of one party, but with all South Africans that ensures our foreign policy is driven by our interests alone.”
- South Africa’s economic situation has changed “adversely and significantly” since the February budget, and the “risks into the future remain high”, finance minister Enoch Godongwana said in parliament on Tuesday. A major contributor was the higher-than-expected public sector wage increase agreed to with trade unions earlier this year. High inflation also increased the government’s borrowing costs.
- The current economic situation in South Africa could make it counterproductive for the country to keep raising interest rates, damaging a fragile economy, and pushing the rand even lower. This is according to economists at Goldman Sachs International. The South African Reserve Bank’s current aim is to support the rand to cut the cost of imports and ease pressure on inflation. On Friday, 12 May, the local currency hit R19.50 to the dollar because of diplomatic tensions over US accusations that Pretoria helped ship arms to Russia. This resulted in inflation expectations moving above the central bank’s target range of between 3% and 6%. It also increased expectations over more interest rate hikes, likely 50bps, when the MPC meets next Thursday. In addition, the import bill could increase R110 billion this year because of the weaker rand. The current issues with Eskom could also well lead the country into stagflation, a situation in which inflation rate is high, the economic growth rate slows, and unemployment is at elevated levels.
- Should Eskom’s worst-case scenario of record Stage 8 power cuts this winter become reality, the consequences for an economy already battling will be catastrophic. The blackouts and the deteriorating economic outlook have already weighed on investor sentiment, with the rand dropping 12% this year — the worst performance among major currencies monitored by Bloomberg.
- Public enterprises minister Pravin Gordhan had to appear before parliament’s standing committee on public accounts to answer allegations made by De Ruyter in the media, in a presentation to the committee in April, and in his new book — Truth to Power, My Three Years Inside Eskom. The committee was especially interested in claims that the former Eskom CEO told the minister the names of two top politicians allegedly implicated in the sabotage. Gordhan would not provide the names, which had been uncovered by a private investigation, saying that the claims should be approached with scepticism. Probably being somewhat over-defensive, he said the former CEO spent most of his time attending to other matters rather than resolving the power crisis.
- Rating agencies are soon to release reviews of the country’s status, with S&P Global Ratings set to publish later today, and others are expected to follow soon thereafter. All ratings agencies have previously warned that the ongoing electricity crisis would undoubtedly impact economic growth and increase the country’s credit risk. S&P Global has already downgraded South Africa in an unscheduled sovereign debt rating announcement on 8 March, changing its outlook from positive to stable. South Africa is currently at junk status, meaning it is not an attractive destination for global investors.
- South Africa seems to have pushed through a ‘special directive’ ordering Transnet to find harbour space for three Turkish gas-to-power ships in Coega for the next 20 years. This is despite strong opposition from the national harbour authority. The ports authority had indicated that it could not house ships at the port as it needed the space for its own port expansion plans. Therefore, there was no room to accommodate three large ships indefinitely. This was one of the main reasons Karpowership’s bid for environmental approval so it could dock and provide gas as a fuel was rejected two months ago.
- SAA’s interim CEO John Lamola has said that the airline’s takeover needs to happen urgently so it can regain market share. The Takatso consortium’s takeover of SAA, which has been long-delayed, still faces several regulatory hoops before it can be wrapped up. The announcement that the Takatso consortium buy 51% stake of SAA from the state was made two years ago. The Competition Commission has recommended the sale go through, although this must be confirmed by the Competition Tribunal.
- Telkom’s shares dropped more than 30% after it said that it would have to write down its assets by R13 billion. The third-largest telecoms company is battling to deal with issues such as low economic growth rates and technological advances elsewhere. Reported earnings-per-share are expected to drop as much as 485% for the fiscal year that ended in March. Headline EPS, which excludes one-time charges, are expected to decline by as much as 105%. Although all South African mobile operators have been battling with South Africa’s challenges, rivals Vodacom and MTN Group have maintained growth and emerged as the country’s dominant providers. Telkom, a former state monopoly that controlled the legacy landline business, has spent years trying to reinvent itself as a mobile and internet provider but hasn’t been able to keep up.
- Investec, which has its roots in South Africa, increased its dividend as it reported a jump in annual profit, despite weaker global markets weighing on its funds under management. Its dividend of 31p a share was 24% higher year on year, at a pay-out ratio of 45%. Profit for the year to end-March was up 46.9% to £817.4 million. Adjusted operating profit, generated from a company’s core operations, increased 21.6%, most of which came from the corporate and investment banking segment.
- As at the time of writing, the rand was 0.5% weaker for the week while the ALSI was 0.3% lower.
Sources: Dynasty, M&G, Reuters, Bloomberg, Daily Maverick, BusinessLIVE, NYT, WSJ, TechCentral, etc.
