FYI | Oct 08 2013
By Kathleen Brooks, Research Director UK EMEA, FOREX.com
US stock markets have opened lower today [Monday] as we start another week with a partial government shut down and no deal on the debt ceiling in sight. Although there’s hardly panic on the streets at the threat of a US default, there are a few signs that the markets may have been too complacent about the US Congress’s inability to reach a sensible plan to raise the debt ceiling and thus may need to play catch up.
No soft deadline for debt ceiling
Over the weekend there was some talk about when the US would actually “default”, albeit technically. The debt ceiling is reached October 17th; however the $30 billion cash at the Treasury and some shuffling around of US repayments could mean that an actual default may not take place until the end of October. As spooky as that would be, I don’t think that the markets will treat the 17th October as a “soft” deadline and if there is no deal before then we could see the markets react badly.
Remembering August 2011
There are two things on my mind right now regarding the debt ceiling, Firstly, the potential market reaction. Back in 2011 when there was a similar wrangle over raising the debt ceiling the S&P 500 peaked on 7th July, before falling more than 15% from 22nd July. The sharpest period of the sell-off lasted until 8th August; however, the index remained subdued until October. Thus, an actual default could have an even more acute impact on the S&P this time round; it could be a long way down as the index is only 3% from the peak it reached in mid-September. Of course, things are different this time, the Fed is buying $85bn of US and mortgage debt per month, and its tapering programme is put on the back burner for now, which could act as a cushion for markets and a soother for agitated investors.
China and the Fed at risk?
The second thing on my mind is China. China’s government cautioned the US earlier that the “clock is ticking” and reminded US authorities of China’s large investment in Treasuries. Although right now, China’s investment, particularly further out the US curve, is actually benefitting from the crisis (5 and 10-year Treasuries are rising and yields are falling), Beijing may be forced to think twice about the US as an investment destination due to the political uncertainty and risk this poses to China’s investment portfolio. It is worth remembering that China is the world’s second largest holder of US Treasuries behind the Federal Reserve, with nearly $500bn of US debt. This reminds me, if Washington does do something stupid in the next two weeks, it could also decimate the Fed’s balance sheet if it erodes the US’s status as a safe haven, causing them to halt QE early. Although this is the worst-case scenario, a bit of disaster planning never did anyone any harm.
Don’t forget about earnings season
For those who want to rise above the debt ceiling row then the beginning of earnings season could prove a distraction. Earnings kick off after the US market close with aluminium company Alcoa. Although Alcoa was demoted from the Dow Jones index earlier this year, the company is still considered a bellwether and its results could help set the tone for the broader market. We get some of the big banks reporting at the end of this week, it will be interesting to see what type of guidance they give for Q4 due to the uncertainty caused by the US debt ceiling issues.
Of course, if this crisis is resolved quickly then we could see stocks surge and the USD rebound sharply, particularly against the JPY. However, as we have seen in Europe, often it takes market pressure to force politicians to act, thus we may need to see a steeper sell off before the US Congress starts to feel the heat…
Source: FOREX.com and Bloomberg (Prices displayed on the chart might not reflect Forex.com prices)
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