The Federal Reserve Is Planning For A Possible Debt Default

Mac, Ashley and Greg meeting



7/21/11: In the markets, as in life, there are no guarantees but everyone is entitled to their opinion. Here’s my opinion on the financial markets today.

The Nitty Gritty Details:

U.S. stocks opened higher this morning following another solid batch of earnings reports and a big acquisition in the Health Care sector.  Company news helped take some of the market’s focus off of the macro clouds, though those clouds have started to clear somewhat.  U.S. lawmakers continue to “battle it out” to reach a deficit deal this week as the clock continues to tick, while European officials will gather at a summit to discuss ways to contain their sovereign debt crisis.  Meanwhile, some noteworthy economic data is tempering enthusiasm this morning, as China’s factory output shrank in July for the first time in a year and weekly jobless claims inched higher.  European markets are modestly lower in mid-day trading overseas on some soft German data and slowing Chinese manufacturing activity, while Japanese and Hong Kong benchmarks were little changed.  Copper is under some selling pressure on the Chinese data, while crude is up slightly and agriculture commodities are mixed.

Looking back at Wednesday, stocks benefited early in the session from carryover of Tuesday’s renewed optimism that Washington would strike a deal.  However, stocks could not hold that early momentum, leaving the S&P 500 virtually unchanged on the day while the Dow and Nasdaq suffered modest losses.  In addition to ongoing debt ceiling and European sovereign debt woes, lackluster existing home sales also weighed on sentiment.  Commodities were mixed, with crude and wheat higher but most metals down slightly.

Around our financial planning services firm this morning, we were discussing four items that we thought would be of particular interest to our readers:

The Markets Broken Down:

More on the Fed’s “forward planning” for a possible debt default. FOMC voting member Charles Plosser said that the Fed and the Treasury have been preparing for a U.S. default.  Some of the planning is operational and some is policy related, such as whether the Fed could treat Treasuries as collateral for loans.  As for Ben Bernanke’s assertion that a default could have “catastrophic” effects, Plosser was more circumspect, but asked, “Do we really want to run that experiment?”  Plosser’s comments came as President Obama expressed support for a short-term increase in the debt ceiling to allow time for a broad deal.

Germany and France reach a deal to rescue Greece. Ahead of a eurozone summit today and amid warnings about the survival of the euro, Angela Merkel and Nicolas Sarkozy have agreed on a new bailout for Greece following hours of late-night talks, which also included Jean-Claude Trichet.  Details weren’t released, although sources reported that it would include a new rescue loan of roughly $99.51B (US), lower interest rates, and a bond exchange.  To prevent contagion, officials are considering using the EU’s rescue fund to provide precautionary credit lines and to recapitalize banks.

Recent news regarding a number of key market factors has generally been positive and major concerns are beginning to lift. The Federal Reserve QE2 program ended without any disturbance in bond yields.  Earnings and guidance have been better than expected thus far.  The economic soft spot appears to be dissipating as Japan comes back online.  We have seen increased clarity regarding the debt ceiling.  And, there appears to be a breakthrough on the Greek debt problems in Europe.

Markets are getting more support from corporate America. With about 20% of the S&P having reported, results have been overwhelmingly better than expected while guidance has been good enough to keep forward estimates from falling.  Profit margins are particularly impressive, as the majority of companies have expanded margins from last quarter and the year-ago quarter.

I would love to hear your thoughts and comments, so email me here .  I enjoy the “intellectual debate” with our clients and friends that these opinions generate.

Greg Powell, CIMA
Wealth Consultant

Note: The opinions voiced in this material are for general information and are not intended to be specific advice. Any indices such as the S & P 500 can’t be invested into directly. Past performance is no assurance of a future result.

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