6 Truths About D.C.'s Debt DebacleLearn more about this firm
Fact is, the real deadline for staving off a US default is Nov. 1, not Oct. 17. But the longer the current fiscal fight drags on, the worse the impact on consumer confidence and, potentially, the economy.
Stock investors have been incredibly patient over the past few weeks. In the first week of the government shutdown, they appeared stoic as we saw only a modest drop in stocks after the first closure in 17 years. In the second week of the shutdown, they showed more anxiety, but reacted positively to any signs of progress in the negotiations, which meant stocks actually finished higher for the week. As we enter the third week of the shutdown, and the Oct. 17 debt-ceiling deadline looms, the stakes are much higher now. And investors’ patience could turn to panic if we don’t get some concrete answers soon.
Still, there are good reasons to stay calm. Here are six important things investors need to know about the unfolding D.C. debacle:
- The debt-ceiling debate is nothing new for the United States. Over the past century, Congress has had a number of dust-ups over the debt limit. Ironically, the debt ceiling was conceived under the Second Liberty Bond Act of 1917, which wasn’t intended to curb spending but to give the US Treasury a wide berth so that it could borrow money to fund World War I. Congress later amended the law to raise the debt ceiling in order to further fill its war chest. Amendments have been raising the debt ceiling ever since—but not without controversy—as it has become a political football in the fiscal-spending debate.
- The deficit shrunk this year. Many Americans don’t understand the difference between the national debt and the deficit. The US government runs an annual deficit each year, which contributes to the existing national debt. However, the annual deficit actually decreased from last year and it’s smaller than expected thanks, in part, to higher tax revenue and cost savings from the sequester. What that means is if Congress wants to find some temporary patch for this crisis, then it has more flexibility to do it given that this year’s deficit is running lower.
- Oct. 17 is not necessarily the crisis date. While several global bank executives as well as the World Bank issued warnings about the dire implications of not striking a deal by the Oct. 17 deadline, there’s actually some wiggle room. The federal government spends most of its money at the start of the month—Social Security and disability checks, for example. However, every day we move closer to Nov. 1, the risks grow dramatically.
- The greatest threat these fiscal fights pose is damaging consumer confidence. Consumers, who had been showing signs of strength, are now weakening. For example, both the Gallup Consumer Economic Confidence Index and Gallup US Consumer Spending Index are both down. And the October IBD/TIPP measure of consumer confidence plummeted to 38.4 from 46.0—a more severe decline than what other recent consumer measures have shown. The shutdown also threatens to derail business confidence.
- Central bank easing will likely continue. The Fed, especially under new Chair Janet Yellen, is likely to maintain its very accommodative stance for longer. While the FOMC minutes showed some dissent on the decision not to taper in September, it seemed clear that a number of members were concerned about whether the economic recovery was strong enough to begin paring bond purchases. Given tightening financial conditions this summer and a prolonged government shutdown, the economy may have already taken a hit. Some market observers now expect the Fed to postpone tapering until March 2014.
- There’s a chance we could see an unconventional solution, at least temporarily. In 1953, the US Commodity Credit Corporation resorted to borrowing money from private banks and other lenders to avoid exceeding the debt ceiling in place at that time. Strategists seem to be giving some credibility to proposals such as the “super premium bond,” a US bond that could be issued at a face value that’s not in violation of the debt ceiling but sold for a much higher price. This bond would enable the government to bypass congressional approval in order to raise the money it needs.
Odds are US lawmakers will reach a temporary solution to the debt crisis before we hit the critical Nov. 1 deadline. Still, we should see some significant volatility in the stock and bond markets before the crisis is resolved. Investors with long time horizons shouldn’t get scared, rather they should look for opportunities to add risk assets to their portfolios.
Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors.She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
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