Market analysts and investors around the world remained on edge Sunday as Congress continued to work out a deal to avoid a U.S. debt default.
If there is no agreement to raise the nation’s borrowing limit and defuse the building financial crisis, analysts say they expect Monday to bring a steep slide in stocks across the globe.
In the U.S. that would add to six straight days of stock losses. The Dow fell 581, or 4 percent, in that time.
John Brady, a senior vice president for futures and options at MF Global predicts the Standard & Poor’s 500 index could fall another 7 percent on Monday if a deal falls apart. The S&P closed at 1,292 on Friday and was down 3.9 percent last week. A loss of the size Brady suggests could send the S&P down to 1,200, a level it hasn’t seen since last November.
The Treasury Department has said that after Tuesday the U.S. government won’t have enough money to meet all of its financial obligations if Congress does not raise the nation’s debt ceiling. If a deal is not reached, the Treasury Department will have to decide which bills to pay and which to delay. Among them: interest payments on bonds, salaries of federal employees, and Social Security payments to retirees. The Treasury Department has not indicated which payments will take priority if the debt ceiling is not raised.
Treasury bonds have long been considered the world’s safest investment and are a top holding of the largest pension funds in the U.S., the Chinese government and millions of Americans who own mutual funds.
Thomas Tzitzouris, head of fixed income research at Strategas Research Partners says to avoid a steep decline, the market needs to at least see some progress.
If not, he says: “That would be a double whammy. When (Congress says) there is progress and then there isn’t, that really spooks the market.”
That’s exactly what happened last week when a series of proposals gave investors fleeting hope for a deal. That is, until one party or the other shot them down. Nearly every measure of market confidence fell last week as Congress edged closer to Aug. 2 without a deal. The price of gold rose 2 percent for the week. The price of gold tends to rise when investors aren’t confident about other investments. A measure of stock market volatility, the VIX, jumped 6 percent.
On the other hand, if a deal is reached to raise the borrowing limit, MF Global’s Brady says the S&P 500 could add 6 percent.
“Stocks will rally, and stocks will rally big,” Brady said.
A deal would remove a major source of something investors hate most: Uncertainty. But there’s another reason the so-called deal rally might be a big one. Companies have reported strong earnings in recent days, but traders have been reluctant to buy stocks because they were afraid the debt wrangling in Washington might set off a financial crisis. In turn, the yield on the 10-year Treasury sank to its lowest level of the year on Friday, 2.80 percent. Treasury yields fall when demand for them goes up. Demand tends to rise when investors are reluctant to put money in stocks.
“If this issue can be taken out of the headlines and the focus on Washington can be redirected toward corporate earnings and economic fundamentals, the market will have removed a significant obstacle,” said Quincy Krosby, chief market strategist at Prudential Financial.
Even so, there are other problems suppressing investor enthusiasm. A report Friday said that the U.S. economy grew at an annual rate of only 1.3 percent between April and June. This year, the economy has grown as its slowest pace since the recession ended in June 2009 ? just 1.7 percent. A debt deal that significantly cuts short-term government spending could further weaken the economy, experts say.
Even with a deal to raise the borrowing limit and cut spending, analysts say companies won’t be ready to hire workers and invest in new projects until some other Washington issues are resolved, like the cost of health care legislation passed last year and financial reform legislation.
Analysts say that if a deal is ultimately reached before Aug. 2, investors will chalk up the market-rattling debt drama as another example of ultimately harmless Washington theatrics.
If the current deal falls apart, however, they say politicians will have done lasting damage to the nation’s credibility. Over time, this could make U.S. government debt less desirable to the worldwide market. That, in turn, could raise the cost of borrowing for the U.S. government.
Lawmakers expressed optimism that a deal could yet be reached Sunday. A number of other promising deals have fallen through in recent days. This has left some investors frustrated at Washington for adding to the economic uncertainty by failing to reach a deal before the deadline became so close at hand.
“This is the worst crisis I can remember and I’ve been in the markets for many of them,” said Uri Landesman, the president of Platinum Partners, a New York hedge fund. “There has been incredibly weak leadership all the way around.”
–Associated Press writer David Carpenter contributed to this report.