Wall St takes shutdown in its stride

US stocks kicked off a new month and a new quarter with gains, and global shares rose modestly on hopes that the US government shutdown may not last long.

Hong Kong shares rebounded off a three-week low today, but strength in defensive shares pointed at underlying caution. At midday, the Hang Seng Index, which closed on Monday at its lowest since September 9th, was up 1.1 per cent at 23,106.7 points. The China Enterprises Index of the top Chinese listings in Hong Kong climbed 1 per cent.

Hong Kong markets were shut yesterday for China’s National Day holiday. Those in the mainland will stay closed until next Tuesday.

“Flows are still quite cautious,” said Jackson Wong, vice president for equity sales at Tanrich Securities. “But I think people expect Washington to come to a form of compromise sooner rather than later.”

Wall Street took the partial shutdown of the US government in stride but market analysts expected investor patience to run out if the shutdown lasts more than about a week as a more worrisome battle looms in Congress over the federal debt ceiling.

After more than a week of declining stock prices over worries that political gridlock would result in a shutdown, investors bid up stock prices yesterday at the reality and took in stride closures that threw hundreds of thousands of federal employees out of work.

Opinions over when the political standoff over the budget might end and the extent of potential damage to the economy varied, but most commentators agreed around the idea that the impasse would keep the government closed for about a week. Previous government shutdowns have generally been brief - usually just a few days - and the memory of a late agreement to avert the fiscal cliff in 2012 explains to some extent the sanguine response thus far.

But if the shutdown lasts longer and the date when the US debt limit approaches, markets will be unsettled as the need to raise the federal debt limit could make negotiations more divisive.

Eric Lascelles, chief economist at RBC Global Asset Management in Toronto, estimated that every week the shutdown continued would shave one-tenth of a percentage point off gross domestic product in the fourth quarter.

“It’s a material hit but certainly one that can be absorbed. The question will be whether it lasts longer than the market expects and starts to bleed into confidence,” he said.

Investors figure the shutdown will hurt financial markets eventually and that consequence might be a catalyst for compromise. Yesterday’s rally on Wall Street did not give Democrats or Republicans a reason to budge.

“The immediate reaction of stocks being positive has not provided an impetus for any of the political actors to change course,” said Erich Patten, an equity portfolio manager at Cutler Investment Group in Seattle. “We anticipate stocks will begin to reflect this economic drag within the next week.”

Andrew Wilkinson, chief economic strategist at Miller Tabak & Co in New York, said both political parties appear willing to go off a cliff without concern about the consequences. “A resolution before the weekend would be a decent guess, but that is just a guess,” he said. “The market right now is forgiving, but if this goes on for a long time, that will not last.”

Fear of being blamed for the impasse in Washington will lead one of the political parties to bend, predicted Carl Kaufman, a bond investor at Osterweis Capital Management in San Francisco. Polling shows more Americans are inclined to blame Republicans at this time.

“I don’t think it will be long. When one party feels that the balance of blame is tilting towards them, they usually cave,” he said.

Previous shutdowns haven’t had much of an impact on portfolios. Bank of America-Merrill Lynch found that in 17 shutdowns since 1976 the market dipped, on average, 0.8 per cent during a shutdown, and then bounced after a resolution. However, few of these impasses have occurred as Washington also grappled with the need to raise the debt limit.

Treasury secretary Jack Lew has said the United States would have a difficult time paying creditors and operating the federal government without a debt limit increase by October 17th. A debt default looms as a more dangerous occurrence for markets, as seen in 2011 during a debt ceiling battle that led to a credit downgrade and market selloff.

Some market participants suggested that if a funding agreement is not reached within a week, the budget battle and need to raise the debt limit may end up intertwined.

The shutdown might last two weeks and approach the October 17th date Mr Lew mentioned, “then the whole thing ratchets up in intensity”, said David Kotok, chairman and chief investment officer at Cumberland Advisors in Sarasota, Florida. “The debt limit fight and the budget fight are related in a way so they provide each side with more pressure points.”

The government is unlikely to default, but the standoff may hurt asset prices, especially the 30-year Treasury bond, said Tom Tucci, head of US government debt trading at CIBC in New York. “If you keep going forward with this brinkmanship and the dam breaks, it’s not reversible,” he said. (Reuters)