Debt deadlines could bring more market volatility

BOSTON (AP) ? Investors have barely had a chance to recover from a summer of anxiety.

And now three congressional deadlines loom before the end of the year. Each has the potential to trigger a new round of market volatility:

? Nov. 18: Lawmakers must approve spending plans for the current fiscal year or face a potential government shutdown.

? Nov. 23: A bipartisan deficit-reduction supercommittee must make recommendations to generate at least $1.2 trillion in deficit savings during the coming decade.

? Dec. 23: Congress must approve the supercommittee’s package, or $1.2 trillion in automatic reductions to defense and many domestic programs would be phased in starting in 2013.

It’s bound to keep investors on edge, particularly coming so soon after months of political brinksmanship over raising the government’s debt ceiling. As the year-end deadlines approach, investors will try to gauge whether leaders will agree on big steps to reduce the $14 trillion-plus national debt, or fall short. The continuing partisan tone in Washington doesn’t instill confidence.

It’s hard to know how to manage a portfolio in such times. That’ true whether you’re trying to sock away enough for a comfortable retirement, or you’re a pro like Erik Weisman.

He’s a bond mutual fund manager and economist with MFS Investment Management. Although based in Boston, he keeps close watch on Washington, where he spent five years working for the Treasury Department and International Monetary Fund.

Weisman also tracks Europe, where leaders are struggling to contain their debt crisis. On Sunday, European leaders will hold a summit to discuss how to assist ailing banks, expand a bailout fund, and reduce Greece’s debt load.

As leaders in the U.S. and Europe struggle with a mountain of debt, Weisman worries that volatility will escalate in the stock and bond markets alike. Below are excerpts from a recent interview:

Q: How close do you think the congressional supercommittee will come to reaching its deficit reduction target of at least $1.2 trillion?

A: It seems unlikely that they’ll get that much, and they’ll probably wind up at around half that amount. The higher it is, the more the market will view it positively, and the more likely that Congress will get to work again for the next fiscal year and do something more meaningful to cut the deficit. The less they wind up cutting this year, the debate ahead will become that much more contentious, even after next year’s presidential election.

Q: What’s a worst-case scenario for how the debt issues play out on both sides of the Atlantic?

A: If the plan that European leaders come up with on Sunday is lacking in details, the market will react negatively, because we’ll still be sort of walking blindly, trying to figure out how Europeans will put this all together. If that remains unresolved in mid-November, and in the meantime the congressional committee’s deficit plan ends up a disappointment, investor sentiment would get hit again, and the reaction would be very negative. It’s the combination of those two things happening that I’m most afraid of.

Q: What’s the flip-side scenario?

A: If Europe gets its act together and Congress agrees on a deficit plan that’s better than expected, then investors can put this policymaking risk issue on the back burner for a while and risk-taking can return to the market. But even if the deficit supercommittee comes out with a decent plan, it doesn’t mean the House and Senate will pass it in December.

Q: Which congressional deadline is more important, the one in late November, or in December?

A: The one in November. Whatever the committee comes up with, there will be tremendous pressure on Congress to approve it. That’s especially true if the committee comes out with deficit reductions that are smaller than expected.

Q: If little short-term progress is made on the deficit, do you worry that an agency such as Fitch or Moody’s might downgrade the U.S. credit rating, as Standard & Poor’s did in August?

A: That’s unlikely, because it sounds like those two are placing less weight than S&P on the politics of deficit reduction, and how messy it is. But S&P might downgrade again, given that they have already added politics as a factor in their ratings. It seems they wouldn’t be reluctant to use that as an excuse to downgrade again.

Q: What advice do you have for investors now?

A: Expect greater volatility. Even under best-case scenarios where the debt problems are seriously addressed, the potential for market gains are limited. It takes a long time to reduce debt, and economic growth rates are still likely to remain low. It’s not like we’d be returning to the market heydays, like the late 1980s or ’90s, or that the stock market would return to what it looked like in the mid-2000s.

If no big deficit reduction agreement is reached, stocks could decline in price, but not all assets would. Prices on U.S. Treasurys could rise again just as they did in August, even if there’s another downgrade. Unless you think there’s a true risk that the U.S. will default anytime soon, the safe haven that investors flock to may still be Treasurys, and the dollar. Treasury yields are crazy low now. But if the debt risks aren’t resolved, rates can stay low for much longer that you might expect, or hope.


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