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. 

[Cincinna]

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

[mware]

What the hell. The market is down over 200 points, and this reflects a mostly positive view???

[PBRSTREETGANG]

Brilliant. Dow was in freefall to the close. Down over 260.

[11th Commandment]

The problem with this analysis is that is assumes the issue with the US economy centered around the debt ceiling. The US still has many structural issues-

* Corporate tax rate that is one of the highest in the World.. Yet effective rates are about in the middle. Which means of course that crony capitalism reigns and companies like GE pay zero tax and job creating small and middle size businesses pay the highest rate in the WORLD.

** Over burdened with government regulation. Massive government with bureaucrats that sit around with nothing better to do than to write new regulations.

*** Trillion dollar deficits for the foreseeable future.

**** Horrible energy policy. The cost of energy and transportation is driving cost up that traditional business models no longer work.

***** Health Care. Since ObamaCare puts heath insurance on private employers, businesses refuse to grow.

[meyer]

"Market Views Debt Deal Mostly Positive"

Yeah, pretty positive indeed. The dow is at -265 and gold is $1660 an ounce. The market seems elated!

[filbert]

Congress got their vote.

Now the people who have to pay the bill get theirs. And they’re voting no.

Market edging toward free-fall range now, down 265, 2.19% as of this moment.

[jersey117]

Really? Really?

[Kaslin]

You have to remember the author wrote the article probable yesterday or two days ago. Had he written it this morning or noon, it would most likely be a different article

[tiki]

I read the title and then went to see what the market was doing and yeah, it looks like they just love it, NOT, it is down 265 right now. The Asian and European markets were down too.

[Wyatt's Torch]

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

No doubt. The government is stifling business growth right now for sure and that is contributing to the very poor economic news over the last 3 weeks. The issue on the debt has not weighed on the markets because everyone always expected that to get done.

[DeoVindiceSicSemperTyrannis]

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[UnbelievingScumOnTheOtherSide]

Sounds like the SH*T Michael Medved and Hugh Hewitt have been spewing.

Center “Right” sucks. And everybody on Townhall.com SUCKS!

[upcountryhorseman]

Explain why the DOW has been down all week!