How did the FTSE 100 and S&P 500 do in May?

The S&P 500 was flat for much of May, posting gains of 0.29%. This isn’t necessarily a sign of stagnation, but rather of consistency. The US economy had a turbulent month with the government debt ceiling negotiations going down to the wire, so an overall gain despite this is positive news.

Back on home ground, the FTSE 100 had a slight loss of 3.23%. We also saw inflation fall – down from the double digits for the first time in what feels like forever, from 10.1% to 8.7%. It’s a decent decline, but not as big as was expected. This raises the possibility of another base rate increase on 22 June, but there’s a lot of other ground to cover before we get there.

In other news from the UK, energy bills will come down by around 35% from July, with a new cap being set at £2,074 on 25 May. It was also forecast that the UK will likely avoid a recession in 2023 – with the International Monetary Fund (IMF) predicting 0.4% growth in 2023, where previously it was thought that the economy would shrink by 0.3%.

 

What is the US debt ceiling?

It had a central focus for much of May, and you might have heard some stories spreading doom and gloom about the US debt ceiling and negotiations between Democrats and Republicans to raise it. So, we thought we’d break down the US debt ceiling here to put this story into context.

In a nutshell, the US debt ceiling was introduced in 1917 to help the US finance WW1, and it’s the limit that US lawmakers put on how much money the US Federal Government can borrow. The government can then use it to keep things like social security payments going, and pay Federal Government employees. 

At the moment, the debt ceiling is set at $31.4 trillion, and lifting the debt ceiling doesn’t mean the government can spend more – it just makes it possible for the US to continue to finance its existing obligations.

To borrow this money, the US Treasury issues bonds that are backed by the US government. These are bought by investors with the understanding that the US government will pay the bond back, plus interest, over a set number of years. 

The problem crops up when the US government hits its debt limit, because at that point the treasury can’t issue any new bonds – it’s literally hit the ‘ceiling’. This prevents the government from raising money through bonds – and the government will start to struggle to pay back what it owes to existing bond holders. 

At this point, you’ll start to hear about the possibility of ‘default’. If this happens, it means that the US government can’t repay its existing debt obligations – which is bad news for just about everyone. In the US, people would lose their jobs, mortgage rates would increase, and economic activity would contract. 

Around the world, the effects would be equally disruptive. Investors would lose confidence in US treasury bonds – meaning they would likely sell the bonds they hold, which would in turn reduce the value of the US dollar. And because it serves as the world’s reserve currency, any significant depreciation in the value of the US dollar would mean that certain countries around the world won’t be able to pay the interest on their national debts with their US dollar reserves. This could tip emerging market economies into debt crises of their own.

However, all of this is also known by the US government and US lawmakers – so the likelihood that they will let it happen is slim to none. Whichever political party is in opposition when the debt ceiling needs to be raised often uses the threat of the above consequences to advance their own political and fiscal agenda. 

A game of political chicken is being played by President Biden –  a Democrat – and the Republican Leader of the House of Representatives to come to an agreement on what compromises need to be made in order to raise the debt ceiling so the US can continue to meet its current debt obligations.

At the time of writing, a deal has been agreed in principle but needs to be voted through Congress ahead of a 5 June deadline. Should this pass as expected, it will likely have a positive impact on stock markets going into June. 

 

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