Market Views Debt Deal Mostly Positive

Townhall.com ^ | August 2, 2011 | David Malpass

[Kaslin]

The House and presumably the Senate have finished a last-minute deal to increase the debt limit.  While it doesn't provide structural reform or much in the way of spending cuts, we think it is otherwise a better-than expected outcome for financial markets.  

 

It should strengthen the dollar temporarily, lift equities and start the process of moving bond yields up toward more normal levels.  U.S. GDP growth and developments in Europe (particularly EU steps to counter the procyclical interaction between short selling, derivatives and ratings downgrades) are important remaining variables in the strength of the asset reallocation from bonds to equities. 

 

Good outcome for financial markets:

 

• The debt limit deal reduces spending growth a bit and leaves open the possibility of constructive reductions at year-end (and a slim chance of the deep structural reforms the U.S. needs to grow faster.)

 

• The deal may be enough to preserve the U.S. AAA credit rating.  Though S&P asked for $4 trillion in deficit reduction, we think it was more in the nature of encouragement to negotiators than an ultimatum.  The IMF was doing the same.  Many market participants are positioned for a downgrade and are hoping S&P can be pushed into one soon.  However, the combination of this deal along with the spending cuts on the continuing resolution earlier this year is an improvement on the Administration's February blowout budget which didn’t cause downgrade warnings -- making it hard to justify a ratings downgrade now. 

 

• The deal avoids a partial shutdown of federal payments next week (perhaps using a short-term bridge in debt authority to give time for drafting the final bill.)  A shutdown of payments would have created big uncertainties regarding legal authorities, lawsuits and legal precedents.  The number two House Democrat, Congressman Steny Hoyer, was calling for the Administration to use the 14th amendment to keep issuing debt.  We don't think that was ever a real consideration by the Administration, but it gives a sense of the legal chaos that might have occurred next week and was getting priced into financial markets. 

 

• Looking beyond the immediate crisis, the deal doesn't solve U.S. fiscal and monetary problems.  It doesn't slowWashington's boom, improve the spending or debt path, create a process to make better spending decisions, or force the Fed off its weak-dollar policy.  At best, the deal might achieve a back-loaded 4% spending reduction from the super-inflated FY11 base.  It ends up being a place-holder for the 2012 election, with both parties arguing that they are more fiscally responsible.  With the Fed maintaining near-zero interest rates, we expect the dollar to resume its downtrend after a post-deal celebration, with DXY falling to new all-time lows under current policies.    

 

Possible elements of the deal:

 

• It assures a two-step increase in the debt limit of $2.4 trillion to last into early 2013 when a new Administration and Congress will deal with it.  This is a key difference from the Boehner bill passed earlier which didn't assure the President the second increase in the debt limit. 

 

• At the outset, the deal reduces growth in discretionary spending over ten years by $1 trillion (versus $48 trillion or so in expected spending.)  Some of the reduced spending growth is in FY12 and FY13 outlays, but not enough to slow static-model GDP forecasts.  The FY12 deficit will still be over $1 trillion, with FY13 nearly that if the economy keeps growing moderately. 

 

• A bipartisan commission will be created (probably 12 members with 3 each appointed by House and Senate majority and minority.)  It will try to reach a majority agreement to report a bill to Congress that would make $1.5 trillion in additional deficit reduction.  None of it could come from Social Security.  Unclear how tax rates and tax expenditures could be used to meet the $1.5 trillion goal.  See our July 11 Debt Limit Fallback Plan for a discussion of the second step and the choice of a December timetable (which Congress often uses to cut big deals. 

 

• There would be an across the board sequester (reduction in budget authority starting in FY13) unless the commission produces a bill that passes both Houses and becomes law. The sequester would exempt Social Security, but would apply pro-rata to Medicare providers (though such reductions for doctors and hospitals have been tried before and end up being reversed by future Congresses.).  

 

• In the deal, Congress would agree to vote on a balanced budget amendment (the Senate previously rejected a House-passed BBA.)  It would take two-thirds of both Houses to move an amendment forward to the states, which is unlikely.  (In an earlier Boehner bill, Congress was required to actually pass the BBA in order to provide the second step in the debt limit increase.)  The requirement of a BBA vote may cause a few Democrats up for election in 2012 (mostly ones in safe seats) to go on record opposing the BBA in order to provide the one-third needed to block passage. 

[DonaldC]

The DOW reflects the market positive outlook! /sarc

[Ingtar]

I want some of what he is smoking.

[DarthVader]

The Dow Jones is down over 200. I guess the investment community does not share the polticians optimism.

[Fedupwithit]

Yeah, the Dow always sheds 200+ points on good news...

Honestly, did I fall down a rabbit hole? Am I dreaming, or do people really read and believe this bullshit? I know none of us here do, but can the average Joe out there really read this and think it's so?

[_a_0_0_]

Market Views Debt Deal Mostly Positive

say wutt?

[SC_Pete]

Obviously the reader is unfamiliar with markets.

[is_is]

Look at gold and silver charts to see what the market thinks of this deal

[John W]

Looks like it wouldn’t take much to have one of those Fall 2008 last fifteen minutes.

[Wyatt's Torch]

Getting a debt deal was already contemplated by the markets. It was never in doubt. The Dow fell yesterday because of the manufacturing numbers were the lowest in 2-years. It’s falling today because consumer spending (70% of GDP) came in way below expectations. In other words, the economy sucks.

[Sequoyah101]

I think the market is so happy it just took a dump.

What is this guy smoking?

[John W]

The OBAMA economy sucks.

[rogue yam]

He meant markets other than U.S. equities, gold, and Swiss Francs apparently.

[camerongood210]

As of right now, the DOW is down 226.25. The Nikkei shed 120 points yesterday (or 1.21%). If this is a positive reaction, then I would hate to see a negative one.

[MrB]

ALL IS WELL! REMAIN CALM!

[John W]

Almost sorry I swore off the nightly network news some years back. It would be enjoyable watching them attempt to explain the great passing/signing vs. the DJIA. Assuming they would lie.

[Wyatt's Torch]

The OBAMA economy sucks.

Every economic post I put Twitter leads with: The Obama Recovery...

[Sir Napsalot]

>>> Market Views Debt Deal Mostly Positive by David Malpass

Mr. Malpass, just wait a day or two.

Until the ramification of the awfulness sets in.

[DarthVader]

Yes but what goes on in government is a driver for the economy as there are inter dependencies between the two.

[Cincinna]

That’s why Gold shot up over 30 points to $1658 after His Barackness pontificated again from his throne!