Markets react to potential shutdown

At the time of this writing, a U.S. government shutdown seemed likely. Global market certainly reacted as if that were the case on Monday, posting losses. While investors and traders tried to figure out the potential outcome, some were jittery about the pending debt ceiling debate.

Here is the Reuters story:

U.S. stocks closed lower on Monday with just hours to go before a midnight deadline to avert a federal government shutdown, but major indexes ended September with solid monthly gains.

Losses were broad across the board and the decline accelerated in late trading but the benchmark S&P 500 index still ended up 3 percent for the month and 4.7 percent for the quarter. The Nasdaq jumped more than 10 percent for the quarter, its biggest quarterly gain since the first quarter of 2012.

With the law funding thousands of routine government activities set to expire at midnight, U.S. Senate Democrats killed a proposal by the Republican-led House of Representatives to delay Obamacare for a year in return for temporary funding of the federal government beyond Monday.

But market participants have grown accustomed to political battles in Washington resulting in a last-minute accord and voiced skepticism any shutdown would last for an extended period.

“The reason the stock market is not down 10 or 15 percent is because people are going, ‘I’ve seen this movie before’,” said Jordan Waxman, managing director at HighTower Advisors in New York.

Also calming market fears, Standard & Poor’s Ratings Services said the debate over raising the U.S. debt limit is unlikely to change the country’s sovereign rating as long as it is short-lived. In 2011, similar political tension prompted the loss of the United States’ triple-A credit rating.

The Dow Jones industrial average was down 128.57 points, or 0.84 percent, at 15,129.67. The Standard & Poor’s 500 Index was down 10.20 points, or 0.60 percent, at 1,681.55. The Nasdaq Composite Index was down 10.12 points, or 0.27 percent, at 3,771.48.

The New York Times pointed out that declines in confidence might be one of the more damaging aftereffects of the sparring:

But on Monday, economists were scrambling to estimate the more immediate effect on the economy if all nonessential government services were closed on Tuesday.

While many economists have said that the direct blow to the economy would be relatively modest if a shutdown lasted only a few days — as past shutdowns have — the political battles could hurt confidence.

“The hit to consumer and business confidence from such an outcome could be substantial, increasing the shutdown’s effects,” Gennadiy Goldberg, a United States strategist at TD Securities, wrote to clients on Monday.

Any reduction in spending would be problematic because economic growth has already been more sluggish than most policy makers want. The Federal Reserve determined recently that the economy was too weak to withstand even a small reduction in the central bank’s stimulus efforts.

The Fed chairman, Ben S. Bernanke, said during his news conference on Sept. 18 that the budget battles could make matters worse.

“I think that a government shutdown — and perhaps, even more so, a failure to raise the debt limit — could have very serious consequences for the financial markets and for the economy, and the Federal Reserve’s policy is to do whatever we can to keep the economy on course,” he said.

The Financial Times’ Alphaville blog wrote a piece last week about the disaster that breaching the debt ceiling would create and quoting an analyst note from RBC Capital Markets:

Of course, an actual debt ceiling breach is essentially Armageddon. Everyone already knows that. We’ve been scouring our inboxes for helpful research notes on the potential for market disruptions in the period leading up to the deadline, and we finally found one.

Produced by the rates crew at RBC Capital Markets, we post an extended excerpt below and have also chucked the whole thing in the usual place:

The Treasury has said they will run out of borrowing room around Oct 17, at which time they will have roughly $30bn of cash. We think this will allow them to squeak by until Halloween (Oct 31) before they hit the final deadline when they would run out of cash.

But unlike past episodes, it seems that the Treasury is not going to give an exact forecast of when the ceiling will be hit (presumably because they were strongly criticized in 2011 when they had $54bn of cash on the date they said they would be broke). Much like past episodes, namely the summer of 2011, we expect negotiation on this front to come down to the wire.

Let us be perfectly clear: crossing the debt ceiling would be catastrophic.

Well said. Not paying our national debt would be catastrophic. While some traders and investors seem to be relying on rational thought to avoid a government shutdown or to end it quickly, the potential for a government default is frightening. After watching the economy recover, portfolios regain some of the past losses and consumer confidence make some headway, politicians are gambling not only with the future, but also with global confidence levels. None of the squabbles seem worth wrecking the financial system and wiping out investors’ savings. Here’s hoping they can pull it together before mid-October.