Debt ceiling decision may not be the 'silver bullet' we need for economic conditions: Strategist

AlphaSimplex Chief Research Strategist Katy Kaminski joins Yahoo Finance Live to discuss the debt ceiling crisis as an additional pressure point for the banking sector, market sentiment on debt ceiling negotiations, and inflation amid economic uncertainty.

Video Transcript

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- Time now for today's Morning Brief, where we're checking in on the financial sector. If the banking failures since early March was not enough stress for financials, debt ceiling negotiations, they've added a new wrinkle of worry. The already challenged sector is down over 6% year-to-date.

And after a turbulent few months, investors become more focused on the added concerns for banks. Debt ceiling mentions in the financial sector have risen over the past month, according to RBC Capital Markets. Now, this comes as executives make more noise on risks surrounding the debt ceiling debate.

Compared to other sectors in the S&P 500, financials lead the way with the most mentions of the debt ceiling. Financials speak on the matter twice as much as the next concern sector, industrials. While past times Congress always resolving debt ceiling negotiations, investors' concerns, they grow as the deadline of the default that nears.

We spoke with RBC Capital Markets Lori Calvasina yesterday on how past debt ceiling drama has hit markets. And here's what she had to say.

LORI CALVASINA: If you go back and look at every debt ceiling drama since 2011, you've gotten at least a 5% to 6% hit to markets before Congress has gotten around to acting. In major drama years, like 2018, '15, '16, 2011, where there was a lot of other stuff worrying investors, those hits have been more like 10% to 19%. In my mind, we're looking at something potentially like a 5% to 10% hit if Congress really doesn't pull things together soon.

- With more on what debt ceiling negotiations mean for markets, we've got Katy Kaminski, AphaSimplex chief research strategist and portfolio manager. Now, Katy, we could be surprised to the upside. Maybe there's some massive breakthrough that happens later today. But I think that highly unlikely as of right now.

KATY KAMINSKI: Yeah. I mean, I think the challenge with these type of discussions is that they're very low-probability events that have huge impacts. And I think when you think about the banking sector, I mean, they're clearly right in the thick of it. If we were to deal with a default or even a technical default, clearly it's going to be the short-term obligations and things that they're holding on their balance sheets that are in front and center. Hence, it's clear that that sector is the most affected by that. We'll have to see. I mean, I think guessing from my perspective, it's going to take some time to figure out.

- Is this a situation where you're putting on any hedges to prepare for-- I mean, there are different scenarios that you can prepare for, right? You can prepare for stocks falling in advance of the deadline and then forcing the hand in there, an agreement coming. You can game out stocks falling and then them not coming to an agreement and then falling more, right? Are you hedging against those various scenarios?

KATY KAMINSKI: So this is where the point that this is such a rare event scenario it makes it difficult to hedge because it's such-- it's so hard to estimate the probability of this type of event and the agreement of different parties that, I think in the financial markets, you're seeing a little bit of indication of moves in equities. You're seeing some momentum signals moving towards short signals in equities but then bouncing back again. So I think in general, it's very, very hard to hedge something that's this extreme in terms of how large of an outcome with such a low probability. So I think from our perspective, most financial investors are really waiting to see more information. And that's why you see markets aren't going anywhere.

- What would be the piece of information that would absolutely just put wind in the sails of investors?

KATY KAMINSKI: Well, I think the challenge here is we'd have to see a resolution. And I'm sure when we see a resolution, then we'll move on to going back to thinking about inflation, worrying about regional banks, and wondering if a recession is coming. So I think the sad part is there's not-- it feels in some sense that the debt ceiling discussion is more just another thing to worry about. And there's really no silver bullet of something that we can find that's going to make conditions change.

I think we need to see inflation back down to target levels because today's retail numbers basically show us that the stress and this unsustainable impact of inflation is affecting the consumer. How long is it going to take? I don't know.

- And so if that's a question, I mean, nobody seems to know, least of all the Fed, right, how long that's going to take. I mean, I mentioned earlier, we heard from Cleveland Fed President Loretta Mester this morning, saying that rates are not at a sufficiently restrictive level if you're looking at the data right now. So that doesn't give a lot of credence to the idea that the Fed is going to be cutting sometime this year, certainly.

KATY KAMINSKI: I agree. And one of the challenges, everybody is looking for Fed cuts. They're thinking, oh, wouldn't it be great if we had rate cuts this year? And what I think is hard about that is you have to think about what we'd have to see for the Fed to cut. And, honestly, it would have to be deterioration in financial conditions to a level that's even worse than the concept of the rate cuts themselves, in my opinion.

And so I think the better thing to think about is it's really a period where we've had a lot of monetary policy. It's a blunt tool to deal with the inflation problem. It's going to take time and data to figure out how long it takes to cool down inflation, which is not an easy thing to deal with. And as we move through that, we're going to have to wait and see and hope that we don't have an overstep in policy, such that we end up with a cycle, like a deflationary cycle or a recession, that causes us to lose some value later this year. And I think that's what everyone's afraid of, to be honest.