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U.S. Debt Deal: ETFs to Win/Lose

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The debt deal involves a cap on government spending, which could dampen the positive effect of fiscal policy on the US economy. The spending limits are expected to be applied starting with the fiscal year beginning Oct. 1.

Two weeks before the debt-limit deal, economists had expected chance of a recession in the coming year at 65%, a Bloomberg survey showed, quoted on Yahoo. The spending cap will likely worsen scenario. This means that the reduced fiscal spending could have a larger negative impact on the economy during a downturn. Cost of debt deal may result in a 570,000 jobs-hit to U.S. employment, per Bloomberg.

Stricter Fiscal and Monetary Policy

The deal would result in a slightly more restrictive fiscal policy at a time when monetary policy is also tightening. Both the Federal Reserve and the government seem to be pulling back support to the economy, which could lead to amplified risks.

Is It All Edgy?

Probably not. Rosy picture lies here too. If the reduced fiscal spending lowers inflation, the Fed may act freely and may not see the need to hike rates further from here. Inflation will be cooled by the process of debt deal and the apparently coming recession.

Big Tech to Win – ETFs like Technology Select Sector SPDR ETF (XLK - Free Report) should soar ahead as rates will likely to take a dive.  With the tech sector being in high momentum with all that AI-frenzy and cheaper valuation, now would be the time for the space to rally.

Consumer Not to Take a Backseat – Unemployment is at its lowest in more than a half century, at 3.4%, helped by historically high demand for workers. Consumers still have excess savings, a San Francisco Fed study showed recently, quoted on Bloomberg. This along with lower rates and likelihood of affordable energy prices should put iShares U.S. Consumer Discretionary ETF (IYC - Free Report) in a sweet spot.

Military spending Exempt From Cuts – The deal bolsters the Pentagon’s budget, a move not well received by conservative and liberal lawmakers at the extreme ends of both parties. Still, fiscal conservatives at the Committee for a Responsible Federal Budget lauded the deal. iShares U.S. Aerospace & Defense ETF (ITA - Free Report) is thus a winner.

Social Programs Unscathed – Medicaid, another key assistance program, remains unaffected. Health Care Select Sector SPDR Fund (XLV - Free Report) should thus be a maintained spot. No hard from this deal for the sector.

Likely Pain Points

Small-Caps to Come Under Pressure? – With recessionary fears taking the centerstage and regional banking crisis likely to tighten the lending standard, small-cap companies may suffer as these stocks are domestically-focused. Vanguard Small-Cap Value ETF (VBR - Free Report) may come under pressure.

AdvisorShares Restaurant ETF (EATZ - Free Report) – Some discretionary spending like eating-outs may also get cut if the recession hits the U.S. economy full-fledged. Consumers may opt for the food-at-home option more than food-away-from-home.

Any Long-Term Caveat? Effect on Liquidity and Money Markets

Once the debt limit is suspended, the Treasury will likely increase its sales of Treasury bills to rebuild its cash balance, per Bloomberg. This will create liquidity crisis in the financial system. This situation, combined with the Fed's current process of reducing bond portfolio, could have considerable implications for money markets.

 

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