Aurelia Butler

Economists are becoming increasingly concerned that the US will generate fresh turbulence in the coming weeks when it hits its debt ceiling and is unable to pay all its bills. With the two main political parties unable to agree an increase in the $31.4tn ceiling on US federal debt, Janet Yellen, Treasury secretary, has warned that stop-gap measures to circumvent the limit will run out of road as soon as June 1. At that point, the US federal government would face various unpalatable options, ranging from delaying payments to contractors, social security recipients, Medicare providers or agencies; to defaults on payments on US government debt. It could also carry on spending programmes in defiance of the ceiling. In any of these scenarios, analysts believe a political, financial and economic crisis would be hard to avoid. While the congressional disputes are the most serious for at least a decade, Mohamed El-Erian, president of Queens’ College at Cambridge university, said the expectation was still that a last-minute deal would be struck between Democrats and Republicans. If that failed, “we should expect another layer of financial volatility in a system that has already lost many of its anchors”. “It would come at a time when the global system is facing growth and inflation headwinds, and is also keen to contain the banking tremors to a particular sector of the US system,” he added.Nathan Sheets, global head of international economics at Citigroup and a former US Treasury official, said: “It amplifies all the other concerns that people have.” There was a “multiplicative kind of effect with the debt ceiling, where people are a little more on edge and they’re a little bit more nervous about this kind of systemic risk”.The last time the US was so close to hitting the debt ceiling was in 2011. Even though a deal was eventually struck, four days later Standard & Poor’s, the credit rating agency, stripped the AAA rating from US government debt. The downgrade sent US share prices down more than 5 per cent in a day and exacerbated the deepening eurozone crisis. Michael Feroli, chief US economist at JPMorgan Chase, said that in some ways, particularly with lower unemployment, the US economy was stronger now. However, hitting the debt ceiling would still mark a destabilising blow. “If you have a flu, you don’t want to get hit by a bus. But you never want to get hit by a bus,” he said. “Even if the economy is looking a little bit different [than 2011], it’s going to be a bad situation.”The exact consequences of a repeat flirtation with breaking the debt ceiling are impossible to estimate with any precision. But officials in the US think they would be serious. Federal Reserve chair Jay Powell at last week’s press conference: ‘We shouldn’t even be talking about a world in which the US doesn’t pay its bills’ © Kim Lo Scalzo/EPA/ShutterstockSpeaking at a press conference this week, Fed chair Jay Powell underscored that failing to raise the limit would pitch the US economy into “unchartered territory”. The consequences were not only very uncertain but also “could be quite high”.“We shouldn’t even be talking about a world in which the US doesn’t pay its bills. It shouldn’t be a thing,” he added. “No one should assume that the Fed can protect the economy and financial system and our reputation from the damage that such an event might inflict.”In 2011, the US Treasury had a plan to ensure that the government did not default on its obligations to Treasury bondholders by cutting spending. But this implies huge cuts, which could send the US economy into recession and weigh on global growth. According to the White House’s Council of Economic Advisers, a protracted US default “would likely lead to severe damage to the economy, with job growth swinging from its current pace of robust gains to losses numbering in the millions”. They forecast an “immediate, sharp recession” with the intensity of the downturn seen during the global financial crisis more than a decade ago. Even a default that is corrected quickly could prompt a sharp drop in growth. Economists from Moody’s warn that 2mn jobs could be lost under such a scenario.

Economists at the Brookings Institution, a Washington think-tank, cautioned in a recent report that even a shortlived impasse would lead to “sustained — and completely avoidable — damage”. Wendy Edelberg and Louise Sheiner, the authors, said the extent of the damage depended in large part on how the government chose to prioritise its payments — something that would inevitably result in legal challenges. El-Erian said the financial effects of a default on debt were “potentially bigger” than delaying other government payments, but even in the latter scenario, “there would be concern about the potential economic spillovers”.With so much at stake, analysts have begun to pepper notes to clients with warnings. Evan Brown and Luke Kawa, at Swiss lender UBS, said any default on US debt would constitute a “major financial crisis” and would therefore be unlikely because the Treasury would prioritise honouring its obligations. Ironically, a downturn in growth could boost US government bond prices as it would lead markets to price in more interest rate cuts from the Fed later this year.Bank of America analysts have said, while reports of the replacement of the dominant role of the greenback in global transactions were “greatly exaggerated”, defaults from a debt ceiling showdown “would compromise the dollar’s attractiveness as a store of value”. More

US and European companies have blamed disappointing earnings on a slower than expected economic rebound in China, after the country’s sudden reopening from pandemic restrictions prompted over-optimistic growth forecasts.Cosmetics group Estée Lauder was the most high-profile example this week, suffering its sharpest one-day share price fall on record after it cut sales forecasts because of a “far more volatile . . . and more gradual” recovery in Asia than it had expected. It was one of a growing number of companies from consumer-focused chains such as Starbucks to big tech groups and logistics businesses all striking notes of caution over the past two weeks.“The overall expectation was, following the reopening, the China market was going to bounce back,” Qualcomm chief executive Cristiano Renno Amon told analysts on Wednesday. “We have not seen those signs yet.”Qualcomm’s rival and onetime acquisition target NXP Semiconductors provided a similar warning the previous day, noting that “it’s too early” to talk about a China recovery. “We’ve seen a modest, gradual improvement . . . from a very slow start,” said chief executive Kurt Sievers.Several consumer-facing groups also cautioned about the pace of the recovery, particularly those that — as with Estée Lauder — rely on travel spending. Hilton chief Christopher Nassetta said: “China won’t contribute what I would have hoped it would this year”.Finnair, meanwhile, noted the recovery had been “slower to start than many anticipated, while Colgate-Palmolive said: “We have not seen the travel retail business come back yet”. Starbucks said it had seen a “robust recovery” in the first three months of the year, but added that growth had already started to slow and highlighted “uncertainty in the overall environment”, particularly in areas such as international travel.The comments came despite official figures showing a robust start to the year for China’s economy, with gross domestic product on track to meet or exceed Beijing’s target of 5 per cent annual growth. David Donabedian, chief investment officer at CIBC Private Wealth, said the divergence reflected the fact that some observers had simply been too optimistic in predicting “an explosion” in activity, while some had also been hoping for more accommodative monetary policy to turbocharge growth.“There was the expectation that it was going to be like a coiled spring . . . there was a pick-up, but no explosion.”Some companies that had not set expectations too high were able to benefit. Adidas, for example, reported falling revenues and continued “uncertainty” in China, but its shares nonetheless jumped 8 per cent on Friday as it said it was seeing “a positive trend” after several years of challenges. The shift in growth expectations is taking place against a backdrop of wider concerns among business leaders about Beijing’s scrutiny of US companies’ operations in China. Following raids on the Chinese offices of Bain and other consultancies, the US Chamber of Commerce said China’s new counter-espionage law “dramatically increases the uncertainties and risks of doing business in the People’s Republic.”Tim Ryan, US chair of PwC, noted in an interview that US companies’ awareness of “concentration risks” in China had grown from the tariff battles early in the Trump administration to the supply chain disruptions caused by the pandemic. “To be clear, I’m not seeing a decoupling” between the US and China, he said: “What I am seeing is more attention to how do you manage risks. What’s happened in the past couple of weeks is more validation that they need to continue to manage risks,” he said. More

President Luiz Inácio Lula da Silva wants to ease constraints on government spending in Brazil, expanding the role of the state in Latin America’s largest economy despite investors’ concerns.Brasília is poised for a congressional vote in the coming weeks on draft legislation that will ensure real expenditure rises every year. If passed, the changes would enable the veteran leftwinger to allocate extra funds for infrastructure and welfare benefits, critical planks of the president’s pledge to end hunger in the nation of 208mn. However, it would also mean breaking with a cap limiting budget increases to the rate of inflation. Introduced in 2017, the spending ceiling has become a pillar for the state’s fiscal credibility and has helped stabilise the South American nation’s level of indebtedness. Ministers say Lula will strike a balance between fulfilling campaign promises and responsible management of the public accounts by committing to a balanced budget in 2024. They also point to the president’s record during his first two terms in office between 2003 and 2010, when he rode a global commodities boom to lift tens of millions out of poverty through welfare programmes, while largely respecting economic orthodoxy. But that has not prevented market disquiet about a possible leftward lurch towards less business-friendly policies. Worries have been compounded by the president’s frequent attacks on the country’s independent central bank, accusing it of denting growth by maintaining its benchmark lending rate at 13.75 per cent. Of particular concern is the impact of the extra spending on public borrowing, which is relatively high for a developing economy at 73 per cent of gross domestic product. “The new framework is unquestionably worse than the previous one when it comes to debt sustainability,” wrote Marcos Casarin, chief Latin America economist at Oxford Economics.

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Market reaction to the new fiscal regime has been mixed so far. The target to eliminate a budget deficit next year has provided a degree of reassurance to some money managers.Jared Lou, portfolio manager at William Blair, said: “We dislike the notion that a spending ceiling is being swapped for a spending floor, but we applaud the government’s intention to achieve a primary surplus in the next few years.” While the new rules stipulate spending must grow annually by a minimum of 0.6 per cent above inflation — even when revenue collection falls — there is a maximum threshold of 2.5 per cent. Under the proposals, annual expenditure is allowed to rise by up to 70 per cent of the preceding year’s increase in government income. This drops to 50 per cent if budget targets are missed.

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To balance the books, finance minister Fernando Haddad intends to raise R$150bn ($30bn) by clamping down on tax evasion, closing loopholes and imposing duties on online gambling. Officials forecast total public revenues of R$2.37trn this year.However, investment bank BNP Paribas said Haddad’s aims of eliminating the budget deficit — not accounting for debt interest payments — next year and generating a surplus by 2025 was “only achievable with tax increases and very optimistic assumptions”. “When we play with the numbers we don’t get a primary surplus in two years, or the debt stabilised in three,” said its head of Latin America research, Gustavo Arruda. “The government is assuming much stronger growth than we believe is Brazil’s potential.”Alberto Ramos, head of Goldman Sachs’ Latin American economics research team, said the new fiscal framework lacked teeth.“There is no trigger mechanism that automatically forces some kind of adjustment if you don’t meet the targets. There’s no administrative penalty or sanction.” Instead, the president would have to write to Congress explaining why goals were missed and outline remedial measures. The exemption of certain areas from the rules, such as spending on federal universities and environmental projects — along with the creation of a floor for public investments and promises of higher minimum and public sector wages — would make it difficult to keep expenditure within the permitted band, Ramos added.

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Another worry is that Lula may encounter political pressure from more radical elements of his base not to restrict public spending.Designed to restore Brazil’s battered public finances to health following the economically disastrous presidency of Dilma Rousseff, Lula’s handpicked successor, the 2017 cap has long faced criticism from the left that it squeezes funds for essential public services and infrastructure. However, the ceiling was legally bypassed to allow for Covid-19 support measures and again last year by Lula’s predecessor Jair Bolsonaro to boost handouts ahead of his failed re-election bid. Lula also obtained a congressional waiver before taking office to increase the payments further. But a deeper problem is the chronic misallocation of Brazil’s state resources, experts say, along with its complex tax system. More than 90 per cent of the country’s budget consists of mandated spending, mostly on pensions and public sector salaries, which can only be changed with congressional approval.

Lula’s task now is to guide the bill through a fickle and fragmented Congress, where his Workers’ party does not command a majority. Rodrigo Pacheco, president of the Senate, told a conference in London last month that he expected the fiscal framework to be approved, although with some changes that he declined to specify.Lucas de Aragão, partner at political consultancy Arko Advice, said the conservative-leaning Congress was unlikely to want big rises in spending.“Congress is more conservative and right-leaning [than the president]. It has become more fiscally responsible . . . This reduces the space for adventurous spending.”Additional reporting by Carolina Ingizza and Michael Stott More

Will US inflation continue to fall? Headline US inflation has been falling consistently since last summer, but economists and analysts believe progress may have stalled in April, as higher prices for core goods counteract cooling costs elsewhere. The Bureau of Labor Statistics on Wednesday will release its latest US consumer price index report, which is expected to show headline consumer price inflation at an annual rate of 5 per cent in April, the same as in March, according to economists surveyed by Bloomberg.The rate has been dropping every month since hitting 9.1 per cent in June last year. From the prior month, prices are expected to have risen 0.4 per cent. Core CPI, which strips out the volatile food and energy sectors, is expected at 5.4 per cent year over year in April, down slightly from the prior month’s rate of 5.6 per cent. While price rises in core services — a category which includes costs related to rent and transportation — are expected to slow, pushing down the overall core figure, analysts at Barclays argued core goods inflation is expected to be higher, driven especially by the rising price of used cars. The figures come after the Federal Reserve this week raised interest rates to a range of 5 per cent to 5.25 per cent, its tenth increase in 14 months. Kate DuguidHow much further will the Bank of England need to raise interest rates? Since the Bank of England’s last rate-setting meeting in March, wage, house price and headline inflation data have all come in stronger than economists expected. With the UK trailing other major economies in its attempt to curb the pace of price rises, traders have upped their expectations of more rate increases to come. Markets are pricing in a near certainty of a 0.25 percentage point rate rise next week to 4.5 per cent, echoing recent increases by the Federal Reserve and European Central Bank. Traders expect rates to peak at 4.75 per cent in September, having only priced in one more rise a month ago. However, the Bank of England’s own messaging has been more prudent. In a speech in early March, governor Andrew Bailey signalled he thought financial markets were wrong to assume the bank would increase rates further.Huw Pill, the bank’s chief economist, has said the BoE needs to exercise “judgment” and should not consider stronger activity to be necessarily inflationary because of the impact from falling gas prices.Annual consumer price rises in the UK stayed in double digits in March at 10.1 per cent, the latest month for which data is available, while average earnings excluding bonuses rose 6.6 per cent year on year, according to the Office for National Statistics.Craig Inches, a bond fund manager at Royal London Asset Management, said he would be “surprised” if the Bank of England does not lift rates by a quarter point given policymakers’ previous insistence that its moves will be “data dependent”. Mary McDougallIs Germany’s manufacturing sector still growing?Germany’s manufacturing sector is likely to have suffered a downturn in March, industrial production figures on Monday are expected to show, following a run of more positive news.Economists polled by Reuters forecast output to have shrunk by 1 per cent between February and March, partially reversing expansion in the previous month.In February, output in the eurozone’s manufacturing powerhouse rose to the highest level in more than two years, approaching its pre-pandemic figures. However, in March, industrial orders collapsed by 10.7 per cent, driven by a sharp drop in motor vehicles.The figures indicated the rebound in German car production “is now reversing”, said Claus Vistesen, chief eurozone economist at Pantheon. He expects a sharp downturn in German manufacturing in the second quarter after the upturn in the first quarter, weighing on investment and inventory accumulation. “This will hold down GDP growth close to zero, even as consumers’ spending begins a gradual rebound,” he added.Holger Schmieding, economist at Berenberg, also expects a fall in March German production data. However, he thinks that would be just a normal correction in volatile monthly data, while production will continue to be sustained by a record backlog of orders accumulated because of supply chain disruptions.“Although they have started to reduce the backlog, the cushion remains comfortable,” he said.French industrial production suffered a larger than expected 1.1 per cent fall between February and March, which reversed the 1.2 per cent rise in the previous month. Italy’s numbers will be published on Wednesday, with the eurozone industrial output figures out on May 15. Valentina Romei More