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Raising the roof

market snapshot

19 May 2023 |
Active ESGMacro
Optimism that a resolution to the US debt ceiling crisis is on the cards helped markets this week. In Turkey, a second-round run-off will decide whether incumbent President Recep Tayyip Erdoğan extends his two decades in power.
  • US debt ceiling impasse closer to resolution – markets take heart
  • President Joe Biden and Republican House Speaker Kevin McCarthy have both expressed optimism an agreement can be reached
  • Turkish presidential election heads into run-off after no candidate secured 50% of the vote in the first round

Markets reacted with cautious optimism this week on hopes that Congress will soon reach an agreement to increase the US debt ceiling.

Speaking in Japan, President Joe Biden expressed confidence that a deal to raise US borrowing is on the cards, avoiding a catastrophic default. Republican House Speaker Kevin McCarthy echoed Biden’s comments, suggesting a bill could be put to a vote as early as next week.

Equity markets responded positively, with first US indices ticking up on Wednesday (17 May) and then their European peers following suit on Thursday morning.

Geir Lode, Head of Global Equities at Federated Hermes Limited, notes that the growing mood of optimism has relieved pressure on most sectors, especially regional banks after a torrid few months, but sounds a warning about the bigger macro picture. “While a debt deal would be a positive, measures of investor sentiment suggest a deeper malaise, and removing this one – admittedly large – risk may not be enough to reawaken the bulls,” he says.

Two decades of rising US debt

Debt ceiling talks have dominated the recent news cycle, but persistent inflation may be a more pressing cause for concern, according to Lode. “There seems to be more talk of a ‘soft landing’ for the economy, but we think this could be overly optimistic,” he says. “Rates have likely peaked and will eventually come down, but there’s a real risk of credit spreads continuing to widen as recession risk persists. We continue to closely monitor the persistence of inflation and the tightness of the labour market.”

For the global equities team at Federated Hermes Limited, elevated corporate borrowing levels are a concern, given the sensitivity of over-leveraged balance sheets to uncertain credit conditions.

Lode notes how commentary over the past earnings season has highlighted the ongoing impact of cost pressures on profit margins, adding: “As interest rate expectations fall, we favour growth stocks with strong, sustainable profit margins: we will look for opportunities in mega-cap technology names with their protective moats, healthy balance sheets and an ability to appeal to both growth-focused and nervous investors.”

The Turkish question

In emerging markets this week, the Turkish national elections loomed large. A first round of voting saw President Recep Tayyip Erdogan take 49.5% of the vote, with his main challenger, Kemal Kilicdaroglu, receiving 44.89%. This clears the way for a run-off on 28 May.

Mohammed Elmi, Senior EMD Portfolio Manager at Federated Hermes, notes that if – as forecasts predict – Erdogan wins the second-round run-off, he will have a simple choice to make: economic orthodoxy or the status quo.

“His room for manoeuvre has narrowed with a record current account deficit of 5.7% of GDP on a rolling 12-month basis, and a deteriorating fiscal position,” says Elmi. “Turkey usually relies on external financing to plug its gross external financing requirements, but the market will be wary and with core rates at these elevated levels, new funding will be tough to secure.”

In this, Erdogan’s choice of appointees to the main economy and finance briefs will be key. “If we see some market friendly appointments, this could be a sign that policy could be evolving in the right direction and, on that basis, bonds could pare some of their recent losses,” Elmi adds.

For further insights on Emerging Markets Debt, please see our Q2 EMD report.

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