The Potential Impact If The Debt Ceiling Is Not Raised

Debt Ceiling image5/16/11: 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:

Stocks will attempt to reverse course this week after falling the two prior weeks – and four out of the past six.  Nonetheless, the S&P 500 is down just 2% from its April 29th peak.  Domestic markets are starting the week off on the wrong foot as European concerns flare up again.  Meanwhile, the U.S. debt ceiling and bearish signals coming from the bond market and recent equity sector performance are adding to the bears’ arsenal and contributing to this morning’s weakness.  Overseas markets were broadly lower overnight.  European markets are focused on Greece’s request for more rescue funds and the arrest of the IMF chief which may delay progress on debt crisis solutions.  Commodities are mixed this morning, as most key agriculture prices and natural gas are higher, gold is holding firm, and oil and silver are lower.

Looking back at Friday, early gains faded as stocks ended lower despite some positive economic data out of Germany, France and Hong Kong.  As was the case all week, stocks moved in the opposite direction of the dollar, with an intra-day rally in the greenback coinciding with the selloff in the stock market.  The U.S. economic data, including the CPI and the University of Michigan consumer sentiment and inflation expectations, had little impact on trading.  All ten S&P sectors were lower, led down by Financials, while Consumer Staples and Health Care held up best.  The broad Commodities indexes were near unchanged, as lower crop prices offset higher energy prices.  The S&P 500 lost just 0.2% in falling for the second straight week.

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

The Markets Broken Down:

  1. Happy Debt Ceiling Day! The Treasury is expected to take additional steps to avoid default despite hitting its $14.3 trillion debt ceiling today.  The actions are intended to give the government until August 2nd to increase the limit.  The two sides in Washington appear far from a deal that would lower spending and lift the limit.  The markets continue to ignore the discussions, expecting no real agreement until July.
  2. And, what is the potential impact if the debt ceiling is not raised? The Treasury Secretary has warned of default.  This is an extreme outcome, but would likely result in much higher interest rates and a plunge in the dollar.  On the other extreme, aggressive spending cuts or tax increases could tip the U.S. economy back into a long and deep recession without the benefit of policy stabilizers.  A more likely outcome is that the limit is raised only modestly in exchange for modest spending cuts, kicking the can down the road until 2012 when the GOP may also control the Senate and larger spending cuts in the trillions could be realized.
  3. As the market debates commodity prices and the fate of Greek debt, investors will absorb data for April and May on housing, manufacturing and leading economic indicators. In addition, the markets will also digest the weekly readings on chain store sales, mortgage applications and initial filings for unemployment insurance.  The Fed will release the minutes of the April 26-27 Federal Open Market Committee (FOMC) meeting and several voting members are scheduled to make public comments this week.  Overseas, it looks like a quiet week for central bank activity, as the only notable central bank meeting to set policy this week is the Bank of Japan, although another rate hike from the Peoples Bank of China, which does not have a set schedule for its meetings, could come at any time.
  4. Treasury yields declined on Friday by four basis points on lower inflation expectations despite the CPI report showing accelerating inflation. Dovish comments from Atlanta Fed President Lockhart over the weekend are contributing to lower yields this morning.  Lockhart said that until the sustainability of the economic recovery was clearer, the Fed’s stimulus measures would not be winded down.  Fed futures markets are not forecasting the first interest rate hike until the June 2012 FOMC meeting.

As always, email me here with your questions or comments.  I love to hear from you and thoroughly 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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