We continue to field questions about the debt ceiling, and we still believe a deal will be reached in time to avoid a default.

Our view continues to be that panicking out of the equity market carries more risk than remaining in a portfolio consistent with an individual’s well-reasoned asset allocation.

We also remain cautious to neutral on stocks, with the incoming data showing underlying inflationary pressures remain. This suggests the Federal Reserve (Fed) will maintain restrictive monetary policy while leading economic indicators point to future economic weakness. All of this is discussed below.

Progress on the Debt Ceiling

Despite the negative headlines, we see several developments that show progress in the debt-ceiling talks. After Tuesday’s meeting, the principals agreed to keep talking and another meeting is scheduled for this Friday between Speaker McCarthy and President Biden. Another positive sign is that staff from both sides continue to talk. All of this signals that, effectively, negotiations have begun. In addition, Senate Leader McConnell has been adamant that “Congress will not let the U.S. default.”

Labor Market Remains Tight

Nonfarm payrolls expanded by 253,000 in April, but the prior two months were revised down by a significant 149,000. This put the three-month average gain at 222,000, well below last year’s 399,000 average gain. However, other parts of the report continue to show a tight labor market. The unemployment rate fell to 3.39%, its lowest level since May 1969. Average hourly earnings were also hotter than expected, rising 0.5%, above the consensus of 0.3%. This took the y/y change to 4.4%, which is above what the Fed considers consistent with its 2% inflation target.

Inflation Eases but Underlying Pressures Remain

In addition to wage inflation, the Fed is focused on core inflation, which excludes the volatile food and energy categories. The just-released Consumer Price Index (CPI) showed core CPI grew 0.41% in April, dropping the y/y rate down to 5.54%. While the details of the report suggest that the U.S. economy’s disinflationary trend remains intact, inflation continues to run well above the Fed’s 2% target.

The market is still implying no rate hike at the next Fed meeting, but sticky wage inflation and core CPI suggest the Fed will maintain restrictive monetary policy for the foreseeable future.

Small Business Optimism Falls Further

The NFIB Small Business Optimism Index fell in April to its lowest level since January 2013, and well below the historical average. It is also down 4.5% from a year ago, reflecting worsening business conditions for small firms over the past year. The low level of business optimism and its continued negative y/y momentum are historically consistent with falling economic activity.

Capital expenditure (capex) plans fell to their lowest level in three years. Excluding the pandemic, capex plans were the weakest since December 2012. The outlook for the economy in the next six months worsened, while the share of business owners who thought now was a good time to expand was little changed and near its lowest level since the global financial crisis.

In a sign of easing inflationary pressures, current and planned compensation pressures both eased, with the latter posting its lowest level in two years. Similarly, current price pressures and pricing plans both continued to come down.

Lending Standards Tighten Further

On Monday, the Federal Reserve released its April Senior Loan Officer Opinion Survey on Bank Lending Practices. This is one of the first comprehensive reports on lending standards since the regional bank crisis broke in mid-March. The report showed a further tightening of lending standards that had already moved into restrictive territory due to the Fed’s aggressive hiking campaign. These tighter standards affect business and consumers and suggest a further slowdown in future economic activity.

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