Investors cheer US deal but worry about a permanent solution

While investors were cheered on Wednesday by a last-minute agreement to raise the US borrowing limit and end the government shutdown, their relief was tempered by the knowledge that the deal was far from a permanent solution. And they were tabulating what the long-term costs of the political turmoil could be.

Under the agreement, the US government would be financed through to January 15th and the Treasury would have borrowing powers until February 7th. At that point, sharp political divisions could re-emerge and, with them, more volatility in the markets.

Many investors were left worrying that the budget crises that have become more frequent in recent years could spin on endlessly, with no long-term resolution. "I worry if this becomes a regular feature that all we can do is pass these three- or four-month fixes," said Joe Kalish, the chief global macro strategist at Ned Davis Research. "If that's going to be the case, it just puts this uncertainty into the market on a recurring basis."

For one day, at least, investors breathed a little easier. The Standard & Poor’s 500-stock index ended the day just shy of the nominal record it hit in September (without adjustment for inflation), before the current impasse began. The short-term Treasury bills that were battered over the past two weeks were again popular as investors regained faith that the US government would not default on its obligations.

The congressional battles’ direct effect on investors appears to be somewhat limited. The markets never reached the same level of panic that preceded the previous debt ceiling crisis in 2011 and the so-called fiscal cliff in late 2012. At its low point during the past few weeks, the S&P 500 was down 4 per cent from its nominal high. On Wednesday, the benchmark index rose 1.4 per cent, or 23.48 points, to 1,721.54. During the US government shutdown, it actually rose 2.4 per cent.

The Dow Jones industrial average gained 1.4 per cent, or 205.82 points, to close at 15,373.83 on Wednesday, while the Nasdaq composite index climbed 1.2 per cent, or 45.42 points, to 3,839.43. There has been much more movement in the prices of short-term Treasury bills. Investors worried that the US government might delay some payments on its outstanding debt if the US Congress did not raise the debt ceiling before the Treasury exhausted its emergency borrowing measures.

For a one-month Treasury bill, the yield, which goes up as the debt becomes less popular, rose to a high of 0.35 per cent on Tuesday night after negotiations appeared to be falling apart, compared with 0.08 per cent a few weeks ago. On Wednesday, the yield fell in half, to 0.14 per cent. A six-month bill due on October 31st followed a similar pattern.

There is some concern that the enthusiasm on Wednesday could go too far, given that much of the damage in the markets in 2011 came after politicians voted to lift the debt ceiling. When Standard & Poor’s downgraded the US credit rating a few days later, stocks plunged.

One of the two other main credit rating agencies, Fitch Ratings, warned Tuesday that it had a negative outlook on its AAA rating for the United States. That did not seem to weigh on investors – and Fitch said its review would take months – but if Fitch ultimately lowered its rating, it could wreak further havoc on Wall Street.

Many investors said that, barring a downgrade, attention in the immediate future would most likely turn back to the strength of the economy and the fate of the bond-buying programs the Federal Reserve has used to stimulate the economy.

The shutdown will most likely exert a direct drag on the economy in the fourth quarter. Several economists predicted that growth in the quarter would be reduced by 0.2 to 0.3 percentage point on an annualised basis. The bigger damage to the economy may come from consumers and businesses spending less out of fear for the next budget crisis, which would put a cap on how much companies can grow.

"The uncertainty breeds a degree of overly conservative behavior," said Marshall Front, the head of money manager Front Barnett Associates. "The animal spirits that are necessary to get an above-average expansion in the economy are largely absent."

Of the 10 companies in the S&P 500 that have talked about the coming quarter, eight have provided negative guidance, according to Thomson Reuters. Analysts have also been lowering their estimates for fourth-quarter profits over the past few weeks.

That slowdown, though, may make it less likely that the Fed will pull back on its bond purchases, something that could lift stocks.

For Wall Street, the biggest concern coming out of the current battles is that they will force the US government to pay more to borrow money. For now, rates are falling. On Wednesday, the yield on the benchmark 10-year bond fell to 2.67 per cent from 2.73 per cent late Tuesday.

The rate investors are demanding on one-month Treasury bills is also down from its high, but it is still far above where it was before the crisis began. IHS Global Insight estimated Wednesday that, just from the Treasury auctions held this week, the US government will pay $114 million more in interest than it would have otherwise.

If the US government has to pay higher rates in the future, that will probably lead to higher borrowing costs for homes and cars, given that most loan markets use Treasurys as a benchmark. “It might be a small change, but when you are talking about trillions of dollars of bonds, it adds up,” Front said. Any long-term turn away from Treasury bonds would most likely be driven in large part by foreign investors, like the Chinese and Japanese governments, which are some of the biggest holders of Treasury debt. The willingness of these governments to buy bonds has long driven down the cost of credit in the United States. There have been signs that the Chinese government may use the crisis to try to attract more investors to its currency, the renminbi. So far, overall holdings of Treasury bonds do not appear to be dropping, but each new crisis gives those big investors another reason to want to leave.

“If this becomes a more regular feature, investors are going to look for some alternative,” Kalish said.

(New York Times Service)