A deal to raise the U.S. debt limit has finally been reached. Take a deep breath — but don't relax fully just yet.
The deal still has to pass a vote in Congress, where it might be subject to further debate from both sides of the partisan divide. Furthermore, the deal prescribes spending cuts, which is exactly what the U.S. doesn't need if it does slide into the recession that many economists have been warning about (though this most-predicted recession in economic history always seems six months away).
Still, that Biden and McCarthy have hashed out a preliminary deal should give investors confidence to put aside worries of the U.S. defaulting and return their focus to markets and the broader economy.
But it's not business as usual there — hence my advice not to relax yet. The U.S. economy this year somehow managed to surprise even after a tumultuous 2022 that upended everyone's assumptions.
Inflation is still uncomfortably high. In fact, going by the PCE report, consumers spent more on goods and services in April than in March. This suggests inflation isn't high and moderating — as the consumer price index, another inflation reading, stated — but is high and increasing. Indeed, the PCE report showed spending jumped 0.8%.
As the PCE is the Federal Reserve's preferred inflation gauge, we shouldn't ignore the warning signs of persistent inflation — and potential higher interest rates — that the index is flashing. Indeed, markets are now betting the Fed will raise rates instead of pausing at its upcoming June meeting. There's a 56% chance for a quarter percentage point increase, according to CME Group data. The probability was just 17% two weeks ago.
And it's not just the U.S. that is grappling with unexpectedly stubborn inflation. The same phenomenon can be seen in the euro zone and the U.K, forcing their central banks to consider raising rates further than expected.
In other words, the debt ceiling fracas might soon be over, but that means we're returning to a world of sticky inflation, high interest rates and an ever-impending recession. Hardly a welcome return to normalcy.
