Even With Agreement Is It Now Too Late?

The news on the debt ceiling discussions appeared hopeful on the day.

The big meeting, between McCarthy and President Biden is currently underway.

In the next few hours, during Asian trading, there is likely to be significant breakthrough news.

Which is surprising, looking at the behaviour of the US equity market on the day. The market really should have been drifting higher on positive expectations. Off-setting this were some Fed President comments, confirming my view that rates will still be going higher even if there is a pause, but stocks really should have been firmer.

Either markets are recognising that even with a negotiated resolution this does not mean the debt ceiling will at all be lifted in time, or such an outcome is already fully priced?

It is one thing for the respective leaders in this situation to reach some kind of agreement, but then this has to be approved by Congress. The approval by Congress is not a forgone conclusion. As this is where the respective hardliners on both sides will make their individual stands.

As mentioned yesterday, it may not be viewed as in the interests of some members to give ground. As any agreement would obviously involve.

President Biden is again, on the day, saying there has to be a significant change in trajectory by the Republicans. If this were the case, it is likely many Republicans will not vote for the bill. Similarly, many Democrats will be very staunch in their resistance to spending cuts.

In other words, the hardest work, the biggest mountain to climb, may still lay ahead in any hope for lifting the debt ceiling in time. Before the government runs out of money and there is a US debt default.

It is of course more likely we will receive good news regarding the current discussions during our Asian trading session.

The big what if?

What if, President Biden completely refuses to reduce spending. The Republicans will not accept that in any matrix of outcomes, including accepting default.

While it is reasonable to maintain some optimism here, it is not out of the question we get a “still more work/discussions to be had” outcome on the day.

This could begin to shatter the so far sanguine market attitude to all of this. At the moment markets are only pricing about a 3.5% chance of a default. That number would quickly ratchet higher on a further discussions required outcome.

In 2011, the stock market fell 15% on fears of debt default. This time the market has barely changed.

The market got it wrong in 2011. Is the market getting it wrong again?

Resolution may be largely priced in, but default is not. It may be the case that after a knee-jerk rally on debt resolution, the market will quickly fall back in on itself. A case of ‘buy the rumour sell the fact’ perhaps?

Should the debt ceiling be un-resolved, even for another week, markets could begin to fall away significantly.

Hence defensive postures remain appropriate for the time being.

Clifford BennettACY Securities Chief Economist

The view expressed within this document are solely that of Clifford Bennett’s and do not represent the views of ACY Securities.

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