Since early August, the prospects for a mild landing in the US economy have dimmed. A combination of economic, financial and, perhaps most important, political factors has made it clear that the US is in more danger than is widely believed. Most investors still insist that the United States is the "cleanest dirty shirt" in the global economy. This is mainly due to the US dollar's status as the world's reserve currency, but also because of the dominance and attractiveness of the country's big tech companies.
This year, however, the US market has displayed an unusually high degree of complacency. This complacency is coming back at America's peril. Previously seen as good news, the "strong labor market" is now becoming less favorable as concerns grow that the Fed will be forced to keep interest rates higher for longer and possibly raise them further before the end of the year.
The sharp US-led sell-off in global debt markets has spread across asset classes around the world, underscoring the risks of a confrontation with the Fed. The yield on the 10-year Treasury note has surged to 4.7%, its highest level since 2007. The sudden rise in bond yields has exacerbated economic vulnerabilities.
Signs of recession are proliferating: excess savings accumulated during the pandemic are depleted, credit card and auto loan delinquencies are rising, student loan repayments are resuming, bank lending standards are tightening, auto industry strikes, and most importantly - historical evidence that the full impact of monetary tightening has yet to be felt.
However, the bumpy landing is not just an economic issue, but also a political one, and here investors have yet to begin to confront it directly. This week's ouster of House Speaker Kevin McCarthy by hard-liners within the Republican Party underscored the deep institutional imbalance in Washington. This not only jeopardises US aid to Ukraine, it also reveals the scale of the challenge of tackling America's public debt problem.
The surge in issuance of debt to support the ballooning U.S. federal deficit has sparked concerns and contributed to the rise in long-term bond yields.
It is clear that the imbalance of the fiscal mechanism is the result of the imbalance of the political mechanism. Whether or not former President Trump retakes the White House, Trumpism is here to stay.
The Republican Party coalesced around the former president long ago. The party's nationalism, isolationism and fiscal irresponsibility pose an even greater threat at a time when war is breaking out in Europe, the economy is threatening to slip into recession and markets are increasingly vulnerable to shocks.