US Debt Ceiling – Ground Hog Day

Not this again!

In what is now becoming an all-too-familiar game of chicken, US politicians have entered into negotiations over approval of the latest government budget and raising the nation’s $16.7 trillion debt ceiling. Both are important, but it is the latter that is giving traders sleepless nights. When  we look at the markets today and last week, nothing that is happening is unexpected, accepting it is politicking in the extreme, and market movement is in line with expectation.

Failure to extend the credit limit by 17 October would result in the world’s largest economy running out of money, or in English defaulting. Were this to happen, credit downgrades and market pandemonium would surely follow. Confidence in the US and the global economic recovery as a whole would also falter. This fact has not been lost on the market, with the FTSE 100 shedding 0.5% over the week (a brief rally on Thursday having arrested the fall).

Why will they not therefore solve the problem?

A number of Republicans are refusing to increase the borrowing limit unless Congress delays the introduction of Obamacare, for a year. Some hardliners in the Tea Party are calling for funding for Obamacare to be withdrawn entirely. Democrats have dismissed such notions out of hand.

Despite confidence in many quarters that they will find a resolution, we do not believe they will this time today as both sides seems completely intransigent, but as we have seen before, they have a habit at the final juncture of kicking the can down the road and that is what is being proposed again today. They have until midnight US time or 5am UK time to get something agreed or the US will shut down, but that is phase 1, phase 2 is on the 17th October when the debt ceiling limit is reached. That is the most serious concern.  However, as you can see from the below graph, the US government has traditionally raised the debt ceiling just in time to prevent a default and this has happened 18 times since 1993.

Meanwhile in Italy, Berlusconi is clinging on to power for as long as he can because as soon as he is no longer a politician and therefore constitutionally protected he will be arrested and incarcerated so everything is being done by those around him to protect him and keep him in power for as long as possible. There is likely to be a collapse in government, an election at best and another technocrat government for a period whilst everything is being sorted out.

Why is this different to Syria, or QE reduction in which we were taking a precautionary stance?

Put simply, because today they are playing politics and the serious problem comes mid-October and if they have not sorted it out by then, then we will be taking a precautionary stance again.

You have to remember we have been here before because Congress went through a similar pantomime in 2011.  Then, an agreement was only reached at the eleventh hour. But it was not without cost: Standard & Poor’s stripped the US of its AAA-credit rating for the first time in history. If the US does default, then last week’s “tapering” concerns would look like small beer in comparison. Today no one is talking of a further downgrade and the economic conditions are stronger. We are therefore being more patient, but if we get towards the middle of October and the politicking is still a raging pantomime then we will look closely at protecting capital values.

Today though, because there is no benefit at all from being in cash or stepping out of the game, we are confident that a resolution will be found and by focusing on the economics and seeing more evidence that the global recovery is in place and corporate earnings strong.  We therefore see more logic in staying invested and riding this roller coaster.  The issue therefore today is politics and that is nothing we would follow with any conviction, apart from the strength of the recovery, which is stronger today that it was in 2011.