Daily Market Reports | Jul 26 2011
By Greg Peel
The Dow closed down 88 points or 0.7% while the S&P lost 0.6% to 1337 and the Nasdaq was down 0.6%.
After the closing bell on Wall Street this morning Republican congressional leaders announced they had come up with a new plan. It was not, they noted, the “Cut, Cap & Balance” plan proposed earlier in the House but it did satisfy two necessary criteria. The size of the budget cuts is greater than the debt ceiling increase and there are no new revenues (tax increases). The leaders were at pains to point out that the deal represents concessions granted on both sides, but they were also quick to play politics, putting the blame for the stand-off clearly at the president's feet.
While the day's session indicated little more than the impasse remained, news is that Democrat negotiators appear to have conceded revenue increases as being the ultimate stumbling block and therefore are prepared to back down on tax policy changes. If that is the case, then we may actually be close to a resolution. But it remains to be seen whether the president, who has the power of veto, will allow the Republicans an apparent victory ahead of next year's interminable electioneering.
As for Wall Street, the session was one of caution but not capitulation. Volume was near non-existent, even for the summer season. The VIX volatility index gained 11% but only to 19, and the prevailing feeling is that a resolution will be reached by the end of the week, in some form. That form may yet be a temporary solution, but right at the moment that would be enough for an increasingly frustrated and disgusted market. It may not, however, be enough for the ratings agencies.
If a solution is reached which is not conclusive but merely time-buying then the likelihood is America will lose its AAA rating. How devastating might that be? Well, commentary appears to suggests “not so much”. Irony might even save the day. Because while major investment funds have statutory rules on AAA holdings, most statutes, it would seem, specify “US Treasuries” and not “AAA-rated US Treasuries”. Clearly when the rules were drawn up the funds never contemplated US debt as being anything other than AAA.
And what of America's major creditors? Well, China is the biggest, it (sensibly) has its own ratings agencies and they downgraded the US a while back to much chortling. So if S&P and Moody's take America down a notch or two, they'll only be belatedly moving into line with Chinese agencies. In other words, Beijing is unlikely to undertake wholesale selling of its US bonds – something that would be mutually destructive anyway.
So while no one was much prepared to buy the market last night, albeit the Dow did recover from being 140 points down at one stage, no one was prepared much to sell it either on the basis that common sense must ultimately prevail. The benchmark US ten-year bond rose in yield last night, but only by 4bps to 3.00%. Instead, investors took up protection in the only currency unaffected by debt – gold. It was up US$14.50 to US$1614.80/oz.
Gold's move came despite little move in currencies. The US dollar index fell only 0.2% to 74.11 and the Aussie was relatively steady at US$1.0843. Commodities were also quiet, with silver falling 0.8% and all base metals doing much the same except for aluminium, which has pushed up another 1% higher. Brent oil was down US93c to US$117.94/bbl.
There were, of course, a host of earnings reports out last night, and the results were mixed. After the bell both Netflix and Texas Instruments disappointed on weaker next quarter guidance. On the economic data front, the Chicago Fed national activity index for June came in at minus 0.46 – up from minus 0.55 in May and minus 0.78 in April, but still in contraction.
With a new deal on the table, Wall Street expects discussions to continue this week and perhaps an agreement might be reached on the weekend. So we could be in for a frustrating week unless positive signs begin to emerge sooner. Realistically, the August 2 deadline can be extended to August 8 before anyone doesn't get paid as the Treasury has more in the kitty than it had anticipated earlier. But one doubts whether President Obama would let August 2 pass without resolution anyway, on a perception basis.
For anyone finding this all rather confusing, just imagine a family discussion around the dinner table. You've maxed out your credit card and don't have enough to pay the mortgage next week. You have no choice but to apply for an increased limit on your card but while that will buy time, it will only mean another increase down the track unless you cut back your household spending. Do you take Jessica out of ballet lessons? Trade the SUV in for a micro-car? Ban new clothes purchases? Start shopping at Costco? These are the sorts of decisions the family must negotiate, beginning from a position of widely differing views.
The Australian market pre-empted Wall Street yesterday and overshot, so the SPI Overnight, which was still open for the Republican announcement, is up 22 points or 0.5%.
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