Wall Street not concerned about US debt ceiling hassle or default

In Washington DC, the fight over to raise or not to raise the US federal debt limit grows stranger by the day.

The White House says the limit must be raised by August 2nd, or the government will not be able to pay its bills, possibly including US bonds held around the World. But as the deadline nears, US stocks and bonds, if they could talk, are saying So What!

The DJIA fell 54 pts Thursday, and stands about where it did at the beginning of the month. The yield on the 10-yr T-Bond, which usually rises when investors see it as a riskier bet, is considerably lower than earlier this year. It may seem an odd reaction by investors, it is not.

Take the Who Cares reaction from the bond market. In theory, investors in US Treasury bonds should demand higher interest payments when there’s a greater risk they will not get their money back, in this case, in the event of a default next month.

Instead, the yield on the 10-yr T-Note rose only slightly Thursday, to 2.95%. In February, when the US economic recovery seemed stronger and the debt limit was a distant threat, it was 3.74%.

But in this market size is the Winner. The US has US$14T in outstanding Treasury bonds. That dwarfs government bonds of any other Nation. US debt is held more widely and traded more often than any other government’s IOU.

That matters because pensions, private investment funds and central banks the World over want to know that they can buy and sell these holdings fast, what investors call liquidity.

During the credit crisis of Y 2008, investors bought US Treasury’s because they were perceived as not only safe but liquid.

It is nice that Switzerland is a safe place, but if you’re the Russian or Chinese central bank, it is just too small a place.

Another reason the markets are calm: the US may seem a more dangerous place to park your money given its rising debt, but much of the rest of the World is not doing well, either.

Europe is trying to contain a debt crisis. Yields on bonds of various countries there have gone up recently.

So, the USA looks to be the best in a Bad World, so people have no choice but to invest here.

As for stocks, there is plenty of news, and some very good, to distract players from Washington’s problems.

US companies are issuing their financial results for the latest Quarter, and they are expected to post big profits, + 15%, according to a survey by data provider FactSet.

JPMorgan Chase reported profits + 13% Thursday, higher than analysts had expected. The stock rose sharply on the news.

Wednesday, Moody’s Investors Services warned it might take away the United States’ Top-credit rating if it missed even one interest payment on its bonds.

In testimony before Congress on Thursday, Federal Reserve Chairman Ben Bernanke said a US default could throw the financial system into “chaos.”

The DJIA closed at 12,437, down 0.4%. The S&P 500 closed at 1,308, down 0.7%.

The United States hit its current US$14.3T debt ceiling in May. For a new debt ceiling to last to the end of Y 2012 would require raising it by about US$2.4T.

A default would drive up the cost of government borrowing for years to come. That would translate into higher interest rates for everybody else, making it more expensive for corporations to finance spending projects and for Americans to take out mortgages or other loans.

The bigger fear is that a default could freeze the short-term lending markets that keep money moving throughout the Global financial system. US Treasuries, and other government-backed debt are the most widely used collateral for loans in these markets.

A default and a downgrade of US debt would lower the value of that collateral. Lenders might respond by forcing borrowers to sell other assets to post more collateral. The fallout could resemble what happened when Lehman Brothers collapsed in Y 2008.

The prospect of such terrible consequences may be exactly the reason investors are not all that worried.

One prominent analyst said, “There is just too much at stake politically and economically for a deal not to get done. It seems hard to believe that any politician would want his or her name attached to a default of US debt.”

Many other investors are assuming the same thing. Wall Street has been expecting a deadline-beating deal since the debt-limit became a subject of debate earlier this year.

No one knows how close Washington can get to the deadline without triggering a sell-off, but he says that if enough investors start to worry, the fear could feed on itself.

In financial markets, you are playing with people’s confidence, and if enough people start thinking it is a catastrophe, it could become one. So, I believe that the pol’s are quite aware of the situation and will deal responsibly with it no matter what “noise’ is broadcast from DC or the media. Stay tuned…

Paul A. Ebeling, Jnr.

Paul A. Ebeling, Jnr. writes and publishes The Red Roadmaster’s Technical Report on the US Major Market Indices, a weekly, highly-regarded financial market letter, read by opinion makers, business leaders and organizations around the world.

Paul A. Ebeling, Jnr has studied the global financial and stock markets since 1984, following a successful business career that included investment banking, and market and business analysis. He is a specialist in equities/commodities, and an accomplished chart reader who advises technicians with regard to Major Indices Resistance/Support Levels.