The economy has seen a significant transformation since September 29th, 2017, when the debt ceiling was raised and U.S. debt went up by $800 billion (see chart below from Wolfstreet). From that day on, everything changed. The increase of the debt ceiling is a perfect case study on what can happen to the economy when such fiscal policies are implemented. I'll go over the most significant trends in this article.
First of all, the trade deficit spiked due to all of this new deficit spending (see chart below from FRED). These deficits are projected to exceed $1 trillion next year.
As a result of this trade deficit, the LIBOR rate also went up. The LIBOR rate theoretically incorporates the risk that lenders might not get their money back and that risk went up due to the increased deficits (see chart below from FRED). This rise in LIBOR rate has forced the Federal Reserve to increase interest rates in parallel to reduce inflationary pressures.
The U.S. dollar also got clobbered since then, despite the rate hikes (see chart below of Yahoo Finance).
Curiously, even when short term rates went up, yields on the longer end of the bond market didn't go up significantly, leading to a flattening yield curve (see chart below of FRED). Treasury recently announced that it wants to focus increased issuance in bills and shorter-dated coupon maturities, like two- and five-year notes. That creates relative scarcity at the long end of the curve and a premium at the short end to absorb the extra supply. But this has consequences for the yield curve.
The yield curve is approaching recessionary territory and once it inverts, we will be seeing another recession (see chart below of FRED).
On top of that, the Federal Reserve has started unwinding its balance sheet since September 2017. According to the latest communication from the Fed, the pace of the balance sheet unwinding program has been increased from $10 billion per month to $20 billion per month. The amount would be increased by $10 billion in the next quarter and each quarter thereafter until it reaches a monthly pace of $50 billion per month. This added extra upward pressure on bond yields. Higher yields may have negative consequences on the stock market, housing market.
On the positive side, we see that this deficit spending has spurred economic growth in the short term.
The capacity utilization saw a spike since September 2017 (see chart below of FRED). This also indicates that inflation is going to rear its head going forward.
Interestingly, economic growth can also be witnessed in an improving leading economic indicator. You can see the small spike since September 2017 (see chart below from FRED).
The inventory to sales ratio has also improved. Wholesale sales continue to outpace inventory growth, which will add to economic output and higher GDP (see chart below from FRED).
Projected earnings are also indicating rosy pictures (see chart below from Yardeni). So even though the stock market is very overpriced, the positive earnings in the future could support higher stock prices.
To conclude, since September 2017, the debt ceiling has been removed. A huge amount of deficit spending ($800 billion) has lead to higher yields and a declining U.S. dollar. Higher inflationary pressures have forced the Federal Reserve to hike rates which in turn increased credit risks, seen in the higher LIBOR rate. The yield curve is approaching recessionary territory, but on the positive side we see improvements in earnings, capacity utilization and inventory to sales ratio. Economic output is improving and the leading economic indicators evidence that.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.