Is a US default on its debt unthinkable?

Chief Investment Officer's team

15 May 2023

AT A GLANCE

Last week was negative for most markets, with recession concerns and uncertainty about the US debt ceiling
We do not think a US default will happen but definitely expect volatility to trend higher
We materially increased our allocations to money market, this time by going underweight on equity

Last week was eventful, with good economic data from Asia, a confirmation that inflation stopped increasing in the US but remains a clear concern in the West, and importantly the US debt ceiling issue generating increasing anxiety. Overall, we may only have a limited number of rate hikes ahead, but the pressure will continue to be felt on the economy, especially as it combines with tighter credit standards from banks.

Recession risk pushed stock prices lower last week, now that the bulk of the earnings season is behind us. Bonds were no shelter due to the uncertainty surrounding US sovereign debt. Should we think the unthinkable: a debt default from the world’s largest economy? Most probably not, but uncertainty is everywhere: on the negotiations, on the funding deadline and even on the details of what would happen in case there’s no deal.

Against such a backdrop, our monthly TAA Committee decided to increase our allocation to cash by 2 percentage points, lifting it to a record high +6 percentage points across profiles. We funded this increase by decreasing equities, where we are now underweight for the first time this year. The rationale is simple: we think that volatility should rise, or even potentially spike, given the incredible collection of potential concerns. Cash is King in such a context for its downside protection and flexibility, but in addition, the risk-adjusted yield it provides on a tactical horizon is simply unparalleled with this level of confidence. DM stocks are priced for a perfect scenario that may, or may not, happen. If it does, we believe that stocks from emerging markets would benefit more. If it doesn’t, we will have opportunities to put this ample cash reserve to work down the road. The weeks ahead will be dominated by the US debt-ceiling debate. Stay safe.

Is a US default on its debt unthinkable

Cross-asset Update

Both stock and money market investors are looking to a time when the Fed will be easing, but for different reasons and highlighting a growing divergence between the two. Fed funds futures indicate cuts in the second part of the year that would be coming to pass only if a shock hits the economy, that is a banking crisis or a recession, while equities remain richly valued buoyed by the hope of the easing of policy. The divergence will have to close at some point, and most likely to the disadvantage of equity investors that will have to take stock of an unfavourable outlook. Indeed, Jay Powell in the post-FOMC press conference mentioned that the Fed will give priority to inflation rather than employment in its dual mandate, that makes the hurdle to easing policy particularly high in order to avoid reviving price pressures with premature cuts. The current equity rally does not seem to be on a solid footing either, driven by few mega-caps and skewed towards high quality stocks, pointing to a defensive stance, hence little conviction amongst equity investors themselves.

The transmission channel of a crisis could be provided by the tightening of bank credit as lenders reduce credit supply and set aside liquidity to tackle business volatility and deposit flights. And according to the Fed’s Senior Loan Officer Survey, a quarterly gauge of bank credit conditions, credit data is showing tighter financial conditions, that are already at levels that in the past triggered a recessionary phase. Also, the debt ceiling issue is occurring at an unfortunate time, since as soon as the ceiling is lifted by Congress, significant issuance will be required to replenish the Treasury General Account, that is going to withdraw liquidity from the market. The expectation is for Congress to reach an agreement just before the Treasury runs out of money, projected to occur sometime in early June. The combination of lower liquidity and tighter credit will be a tough test for the still optimistic equity market.

The recent rebound in the US dollar suggests investors may be starting to hedge their bets, as the global reserve currency tends to rise either when US growth beats that of peers, or during times of financial strain. We see more upside on the US dollar also on account of extremely bearish positioning, at least until there is high uncertainty about the odds and extension of a US recession.

Overall, tighter credit conditions, lower market liquidity, a narrow equity rally and a rising dollar bode ill for risk assets in the next few months. Investors are advised to be high in quality across asset classes and keep some cash on the side, along the guidelines provided by our Tactical Asset Allocation Committee.

Is a US default on its debt unthinkable

Fixed Income Update

The US debt ceiling issues has dominated almost every investor discussion we had in the past couple of weeks. The last time it attracted such interest was way back in 2011. Contrary to expectations, the long-duration treasuries rallied as we approached the X-Date then, with the rally continuing a month after the agreement was reached. JPM recently concluded an institutional investor survey on the topic. No wonder expectations mimic last time’s price action. Two-thirds of the correspondents estimate the 10-year to move down by more than 20 bps with a moderately flatter 2s10s curve. An overwhelming 99% and 97% of respondents expect wider IG CDX and JULI spreads, by an average of 44bp and 66bp, respectively.

Dissonance remains between the bond market that expects rate cuts this year and the Fed’s rhetoric of not seeing any rate cuts. The 2-month T-Bills dropped by 36 bps last week. We find the 3 to 5-year treasuries very rich and expect yields to back up by 25-30 bps. 67 bps of rate cuts priced in by the end of this year, which seems a bit excessive, and yields could move up slightly from current levels as the market reprices its expectations. Current credit spreads have been relatively stable and range bound. However, we are wary of the optimism of credit spreads. The HY default rate jumped in April and is expected to continue rising over the coming months due to base effects.

GCC Primary issuance gathers steam this week. After last week’s strong Mubadala issuance, KSA is in the market today for a dual-tranche 6 and 10-year sukuk issuance. The IPTs are wider to the underlying sukuk curve by 40 and 70 bps, respectively, but we expect the final pricing to align with the sukuk curve. The 10-year looks interesting as it extends the sukuk curve by 2 years and may leave some premium for the investors. Nogaholding has issued a tender for its 2024 notes and may issue either a 7 or 10-year sukuk, according to the announcement. Some D-SIBs from the UAE and Real Estate players could also tap the markets this week.

We recommend clients stay within 10% of their Fixed Income AUM on both names combined. Egypt has made a list of 32 issuers for IPO on its local markets. Egypt sold a 9.5% stake in state-run Telecom Egypt Co., raising more than 3.7 billion Egyptian pounds ($121 million) in a signal to investors that the country is serious about implementing a comprehensive economic reform program. Turkey’s close elections have affected the markets as an opposition win was priced in. As a result, the 5-year CDS has widened by 90 bps, and the market will remain volatile.

Is a US default on its debt unthinkable

Equity Update

Excitement continues around generative AI and which assistant will be the best i.e. Apple’s Siri, Amazon’s Alexa or Microsoft or Google’s and this helped tech stocks to another week of gains with the Nasdaq now +18% year to date. Inflation numbers were not alarming, though way removed from central bank’s target and continuing banking sector woes along with the US debt ceiling crunch-time looming had global equities overall lose 0.4% last week with most major markets lower. Exceptions were the KSA, India and Japan.

We held our asset allocation meeting and maintained our emerging market overweight, however on a smaller scale and took the developed market underweight a bit lower. DM equities are +9% YTD, with our fair values for the indexes breached that leads us to believe that upside is limited. We maintained our preference for Japan, neutrality to the US and remain underweight the Eurozone (neutral UK). The earnings season, the main catalyst, is now over and the 3-5% beat (US and Europe) has aided market performance, though it was big tech that provided most of the profit and performance for the S&P 500. Also, the prospect of the Fed being done tightening is aiding growth and long-duration sector performance. Any pullback should be viewed as an opportunity to add as low institutional positioning suggests there’s money waiting to be put back into equities and that could bias investors to be early rather than late in adding risk, with a decent pullback in equities a buying opportunity even before the first rate cut. The low positioning hasn’t aided fund performance as active fund managers have largely underperformed the S&P 500.

Shares of US regional banks continue to fall, deepening underperformance relative to the overall banking sector. The KBW Regional Banking Index fell 6% over the week, year to date -30%. The US has c. 4200 regional banks, many more than most countries and on a percentage basis less than 1% are affected by deposit runs or worries around collapsing due to revaluation of assets. The bigger worry is the consequent credit tightening to smaller businesses and the higher rates (8 to 12%) that commercial real estate cannot afford as those are above the yields (4 to 6%) they generate.

Within the emerging market allocation, we maintain our preference for EM Asia with India as a long-term secular growth story and China expected to rebound in the short term. However, data is yet to show a pick-up in consumption, a lagging effect as China’s import volume contracted last month, while exports expanded slower than expected, heightening concerns over its economic recovery since strict zero-Covid measures were discarded in late 2022.

Our UAE overweight continues with more issuance in the pipeline and the current Adnoc Logistics & Services IPO expected to generate interest from income seekers as another quality company with high dividend yield and growth. In the last 3 years of issuance UAE IPO’s have gained on an average 55% since listing.

Is a US default on its debt unthinkable

Written by:

Maurice Gravier Chief Investment Officer , [email protected]
Anita Gupta Head of Equity Strategy , [email protected]
Satyajit Singh Fixed Income Analyst , [email protected]
Giorgio Borelli Head of Asset Allocation , [email protected]

Disclaimer

This document is prepared by Emirates NBD Bank (P.J.S.C) (“the Bank” or “Emirates NBD”), a public joint stock company incorporated in Dubai, United Arab Emirates (UAE) and licensed to provide various financial services including promotion, financial consultation, securities portfolio management, managing investments of investment funds, etc. Emirates NBD is regulated supervised and controlled by the Central Bank of the UAE (“Central Bank”) and the Securities and Commodities Authority of the UAE (“SCA”), having its head office at Baniyas Road, Deira, PO Box 777, Dubai, United Arab Emirates. This document may be distributed and/or made available by the Bank and its affiliates and subsidiaries, including Emirates NBD Capital KSA CJSC (“ENBD Capital”) (through its website, its branches or through any other modes, whether electronically or otherwise).

Emirates NBD and its affiliates, subsidiaries and group entities, including its shareholders, directors, officers, employees and agents are collectively referred to Emirates NBD Group.

This publication is prepared without regard to the individual financial circumstances and objectives of persons who receive it. Data/information provided in this publication are intended solely for illustrative purposes for the general information or its recipients, irrespective of their customer classification as an Ordinary Investor or Professional Investor under the SCA Regulations.

Any person (hereinafter referred to as “you”, “your”) who has received this document or have access to this document shall acknowledge and agree to the following terms.

Reliance

This publication may include data/information taken from stock exchanges or other third-party sources from around the world, which Emirates NBD reasonably believes to be reliable, fair and not misleading, but which have not been independently verified. The provision of certain data/information in this publication may be subject to the terms and conditions of other agreements to which Emirates NBD is a party. Opinions, estimates and expressions of judgment are those of the writer and are subject to change without notice. Emirates NBD or any member of Emirates NBD Group makes no representation or warranty and accepts no responsibility or liability for the sequence, accuracy, completeness or timeliness of the information or opinions contained in this publication. Nothing contained in this publication shall be construed as an assurance by Emirates NBD that you may rely upon or act on any information or data provided herein, without further independent verification of the same by you.

The contents of this document are prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors, including those relevant to the determination of whether a particular investment activity is advisable. Emirates NBD does not undertake any obligation to issue any further publications or update the contents of this document. Emirates NBD may also, at its sole discretion, update or change the contents herein without notice. Emirates NBD or any member of Emirates NBD Group does not accept any responsibility whatsoever for any loss or damage caused by any act or omission by you as a result of the information contained in this publication (including by negligence).

References to any financial instrument or investment product in this document are not intended to imply that an actual trading market exists for such instrument or product. Certain investment products mentioned in this document may not be eligible for sale in some jurisdictions, and they may not be suitable for all types of investors. The information and opinions contained in this publication is provided for informational purposes only and have not been prepared with any regard to the objectives, financial situation and particular needs of any specific person, wherever situated. If you wish to rely on or use the information contained in this publication, you should carefully consider whether any investment views and investment products mentioned herein are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You should also independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professional advisers or experts.

Confidentiality

This publication may be provided to you upon request (and not for distribution to the general public), on a confidential basis for informational purposes only, and is not intended for trading purposes or to be passed on or disclosed to any other person and/or to any jurisdiction that would render the distribution illegal.

Solicitation

None of the content in this publication constitutes a solicitation, offer, recommendation or opinion by Emirates NBD to buy, sell or trade in any security or to avail of any service in any jurisdiction. This document is not intended to serve as authoritative legal, tax, accounting, or investment advice regarding any security or investment, including the profitability or suitability thereof and further does not provide any fiduciary or financial advice. This document should also not be used in substitution for the exercise of the prospective investor’s judgment.

Third Party

This publication is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. It is the responsibility of any person in possession of this publication to investigate and observe all applicable laws and regulations of the relevant jurisdiction. This publication may not be conveyed to or used by a third party without the express consent of Emirates NBD or its affiliates, subsidiaries or group entities distributing this document. You should not use the data in this publication in any way to improve the quality of any data sold or contributed by you to any third party.

Liability

Notwithstanding anything to the contrary set forth herein, Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries shall not, directly or indirectly, be liable, in any way, to you or any other person for any: (a) inaccuracies or errors in or omissions from this publication including, but not limited to, quotes and financial data; or (b) loss or damage arising from the use of this publication, including, but not limited to any investment decision occasioned thereby. Under no circumstances, including but not limited to negligence, shall Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries be liable to you for direct, indirect, incidental, consequential, special, punitive, or exemplary damages even if Emirates NBD has been advised specifically of the possibility of such damages, arising from the use of this publication, including but not limited to, loss of revenue, opportunity, or anticipated profits or lost business.

This publication does not provide individually tailored investment advice and is prepared without regard to the individual financial circumstances and objectives of person who receive it. The appropriateness of an investment activity or strategy will depend on the person’s individual circumstances and objectives and these activities may not be suitable for all persons. In addition, before entering into any transaction, prospective investors should: (i) ensure that they fully understand the potential risks and rewards of that transaction; (ii) determine independently whether that transaction is appropriate given an investor’s investment objectives, experience, financial and operational resources, and other relevant circumstances; (iii) understand that any rates of tax and zakat or any relief in relation thereto, as may be referred to in this publication may be subject to change over time; (iv) consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment; (v) understand the nature of the investment and the related contract (and contractual relationship) including, without limitation, the nature and extent of their exposure to risk; and (vi) understand any regulatory requirements and restrictions applicable to the prospective investor.

Where this publication provides any information about Shariah compliant products, the Bank will not have engaged a Shariah board (or similar body) to determine independently whether or not such products are compliant with Shariah principles. The Bank accepts no liability with respect to the fairness, correctness, accuracy, reasonableness or completeness of any such determination or guidance by any Shariah board that has certified or otherwise approved such products as Shariah compliant. Nothing contained in this publication shall be construed as a recommendation by the Bank to invest in such product. In deciding whether to invest in Shariah compliant products, you should satisfy yourself that investing in such products will not contravene Shariah principles. You should consult your own Shariah advisors as to whether investing in such products is compliant or not with Shariah principles.

Forward Looking

Past performance is not necessarily a guide to future performance and should not be seen as an indication of future performance of any investment activity. The information contained in this publication does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. Certain matters in this publication about the future performance of Emirates NBD or members of its group (the Group), including without limitation, future revenues, earnings, strategies, prospects and all other statements that are not purely historical, constitute “forward-looking statements”. Such forward-looking statements are based on current expectations or beliefs, as well as assumptions about future events, made from information currently available. Forward-looking statements often use words such as “anticipate”, “target”, “expect”, “estimate”, “intend”, “plan”, “goal”, “seek”, “believe”, “will”, “may”, “should”, “would”, “could” or other words of similar meaning. Reliance should not be placed on any such statements in making an investment decision, as forward-looking statements, by their nature, are subject to known and unknown risks and uncertainties that could cause actual results, as well as the Group’s plans and objectives, to differ materially from those expressed or implied in the forward-looking statements. Estimates of future performance are based on assumptions that may not be realized.

Risk

Data included in this publication may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, and credit risk. Emirates NBD may use different models, make valuation adjustments, or use different methodologies when determining prices at which Emirates NBD is willing to trade financial instruments and/or when valuing its own inventory positions for its books and records. The use of this publication is at the sole risk of the investor and this publication, and anything contained herein, is provided "as is" and "as available." Emirates NBD makes no warranty of any kind, express or implied, as to this publication, including, but not limited to, merchantability, non-infringement, title, or fitness for a particular purpose or use.

Investment in financial instruments involves risks and returns may vary. The value of investment products mentioned in this document may neither be capital protected nor guaranteed and the value of the investment product and the income derived therefrom can fall as well as rise and an investor may lose the principal amount invested. Investment products are subject to several risks factors, including without limitation, market risk, high volatility, credit and default risk, illiquidity, currency risk and interest rate risk. It should be noted that the value, price or income of securities denominated in a foreign currency may be adversely affected by changes in the currency rates. It may be difficult for the investor to sell or realise the security and to obtain reliable information about its value or the extent of the risks to which it is exposed. Furthermore, the investor will not have the right to cancel a subscription for securities once such subscription has been made. Prospective investors are hereby informed that the applicable regulations in certain jurisdictions may place certain restrictions on secondary market activities with respect to securities.

Before making an investment, investors should consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment. In receiving this publication, the investor acknowledges it is fully aware that there are risks associated with investment activities. Moreover, the responsibility to obtain and carefully read and understand the content of documents relating to any investment activity described in this publication and to seek separate, independent financial advice if required to assess whether a particular investment activity described herein is suitable, lies exclusively with the investor.

Intellectual property

This publication has been developed, compiled, prepared, revised, selected, and arranged by Emirates NBD and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, and money and constitutes valuable intellectual property of Emirates NBD and such others. All present and future rights in and to trade secrets, patents, copyrights, trademarks, service marks, know-how, and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, shall, as between the investor and Emirates NBD, at all times be and remain the sole and exclusive property of Emirates NBD and/or other lawful parties.

Except as specifically permitted in writing, you should not copy or make any use of the content of this publication or any portion thereof or publish, circulate, reproduce, distribute or offer this publication for sale in whole or in part to any other person over any medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet or construct a database of any kind. Except as specifically permitted in writing, you shall not use the intellectual property rights connected with this publication, or the names of any individual participant in, or contributor to, the content of this publication, or any variations or derivatives thereof, for any purpose. This publication is intended solely for non-commercial use and benefit, and not for resale or other transfer or disposition to, or use by or for the benefit of, any other person or entity. By accepting this publication, you agree not to use, transfer, distribute, copy, reproduce, publish, display, modify, create, or dispose of any information contained in this publication in any manner that could compete with the business interests of Emirates NBD. Furthermore, you should not use any of the trademarks, trade names, service marks, copyrights, or logos of Emirates NBD or its subsidiaries in any manner which creates the impression that such items belong to or are associated with you, except as otherwise provided with Emirates NBD’s prior written consent. You shall have no ownership rights in and to any of such items.

IMPORTANT INFORMATION ABOUT UNITED KINGDOM

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the London branch of Emirates NBD Bank (P.J.S.C) which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority in the UK. Some investments and services are not available to clients of the London Branch. Any services provided by Emirates NBD Bank (P.J.S.C) outside the UK will not be regulated by the FCA and you will not receive all the protections afforded to retail customers under the FCA regime, such as the Financial Ombudsman Service and the Financial Services Compensation Scheme. Changes in foreign exchange rates may affect any of the returns or income set out within this publication.

IMPORTANT INFORMATION ABOUT SINGAPORE

This publication was prepared by Emirates NBD Bank (P.J.S.C) in the United Arab Emirates. It has been issued and approved for distribution to clients by the Singapore branch of Emirates NBD Bank (P.J.S.C) which is licensed by the Monetary Authority of Singapore (MAS) and subject to applicable laws (including the Financial Advisers Act (FAA) and the Securities and Futures Act (SFA). Any services provided by Emirates NBD Bank (P.J.S.C) outside Singapore will not be regulated by the MAS or subject to the provisions of the FAA and/or SFA, and you will not receive all the protections afforded to retail customers under the FAA and/or SFA. Changes in foreign exchange rates may affect any of the returns or income set out within this publication. Please contact your Relationship Manager for further details or for clarification of the contents, where appropriate. For contact information, please visit www.emiratesnbd.com.

IMPORTANT INFORMATION ABOUT EMIRATES NBD CAPITAL KSA CJSC

Emirates NBD Capital KSA CJSC (“ENBD Capital”), whose registered office is at P.O. Box 341777, Riyadh 11333, Kingdom of Saudi Arabia, is a Saudi closed joint stock company licensed by the Saudi Arabian Capital Market Authority (“CMA”) under License number 37-07086 dated 29/08/2007G (corresponding to 16/08/1428H) to deliver a full range of quality investment products and related support services to individuals and institutions in the Kingdom of Saudi Arabia. ENBD Capital is subject to Capital Market Law, and Implementing Regulations in the Kingdom of Saudi Arabia

ENBD Capital’s contact details are T +966 (11) 299 3900 and F +966 (11) 299 3955.

This document may not be distributed in the Kingdom of Saudi Arabia except to such persons as are permitted under the Investment Funds Regulations issued by the Capital Market Authority.

The Capital Market Authority does not make any representation as to the accuracy or completeness of this document, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of this document. Prospective subscribers of the securities offered hereby should conduct their own due diligence on the accuracy of the information relating to the securities offered. If you do not understand the contents of this document, you should consult an authorised financial adviser.

more app