Clock ticking for US debt resolution

Founder and Publisher of the Switzer Report
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There are about nine days to go before the August 2 deadline for the US Congress to reach an agreement over the Yanks’ deficit and their debt ceiling. So how close are the warring political parties to sealing a deal and how will the stock market react?

In the past week, Wall Street has resumed its leadership role over our stock market — albeit at a reduced rate. What happens at the NYSE is the key determinant of the direction of the bulk of our local equity investments and recently it reacted positively to the latest Greek rescue package. The Dow finished at 12,681, that’s up 1.61% for week and 9.53% for year-to-date!

Meanwhile the S&P 500 was up 2.19% for week and 6.95% for year-to-date. These weekly results show how the market is relieved when one of the three problems spooking US investors, and therefore global investors, is solved. In case you are scratching your head on the three current spook factors, they are the Euro-debt rescue plan, the US debt and deficit and the possibility that the US could lurch back into recession. You can read more about these three in my previous column.

It’s my contention that as each problem is solved the share market will respond positively, as was shown last week when a more believable Greek rescue plan was released. Scepticism still prevails in some quarters regarding the plan, as shown by the fact that gold went over $US1,600 an ounce last week, but the market bought it, at least for the moment. And while the market may change its mind, the fact that the VIX or fear index is at 17.47 shows how low worries on Wall Street are at the moment. Also, the European markets shot up on the debt deal — that’s a nice sign.

Fortunately, US companies are largely reporting better-than-expected earnings, with tech companies such as Apple shooting the lights out and McDonald’s share price hitting an all-time high. So with earnings strong and Europe on the back burner (for now), let’s just focus on the highest risk of the week – the US debt challenges.

Ducks and drakes prevail in Washington, but I suspect something positive will happen this week — well, it better! The conflicting signals from the Democrats and Republicans run up against the logical thoughts that the politicians couldn’t possibly let the US default.

In a nutshell, the Congress has to agree that the strategy to reduce the deficit, which should be a combination of spending cuts and taxes, will permit the majority of politicians to accept a higher debt ceiling. But that’s not the end of it — the ratings agencies have to be happy with the agreement or else they will take away the Yanks’ AAA-rating on its sovereign debt.

Of course, the whole wrangling is not just about what has to be done to get the right numbers; the competing philosophies of the Democrats, the Republicans and the Tea Party are creating roadblocks to progress and agreement — particularly when it comes to taxes.

John Boehner, the key Republican in the battle is frustrated with President Obama’s Democrat stance.

“The president is emphatic that taxes have to be raised,” he says. “As a former small businessman, I know tax increases destroy jobs.”

And while both men have said they were confident that the USA would not default, conflicts remain. Obama says the Republican group doesn’t seem to have the capacity to agree to a debt-limit deal. The ideal plan should mean a US$4 trillion spending cut over a decade and that’s the figure the ratings agencies and the market will use to base their reactions to an ultimate deal.

If the Congress fails to agree there will be a big market sell-off, and that’s why I was a little concerned when I read that the House Speaker, John Boehner, late last week, told reporters that he and Obama “were not even close to an agreement.”

This uncertainty makes the US debt position the big issue of the week and while there are other US developments worth watching — such as the S&P Case-Shiller home price index, consumer confidence, new home sales, durable goods orders, pending home sales, GDP, the Chicago PMI and then consumer sentiment — sealing a debt/deficit deal is the main game in town.

On the local front, Wednesday’s inflation numbers could determine interest rate policy going forward and that could affect our dollar and our share prices, but all that pales in comparison to what shares and the dollar will do if the US fails to pull off a deal with stellar ratings.


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