Muted reaction to US shutdown belies deeper fear of default

Nothing stuns an audience like a cliffhanger ending, but suspense is the last thing investors and the US treasury want from Washington.

Yesterday's market reaction to news the US government would start to shut down numerous agencies after Congress failed to reach an agreement over the budget was, to say the least, relaxed.

The dollar fell to near seven-month lows, rallying later. Gold led a slide in metals. But US stocks rose.

One reason may be the Federal Reserve is now seen as less likely to "taper" its emergency asset-buying. Another is the markets are less worried about a probably short-lived government shutdown than they are about a bigger issue.

Namely, will Congress raise America’s $16.7 trillion debt ceiling before the treasury is pushed into a corner and, possibly, delays making an interest payment on $12 trillion of outstanding government bonds – technically defaulting?

Delayed payment
For investors, bankers and rating agencies, the idea of the US delaying an interest payment is unthinkable. Indeed, given the acrimony in Washington, the bearish scenario is a replay of the events of August 2011, but with a far worse outcome.

In the summer of 2011, the S&P 500 dropped nearly 20 per cent when an 11th-hour deal to raise the debt ceiling was followed by Standard & Poor’s stripping the US of its triple-A rating.

The next two weeks will be crucial. "This is a low probability event, but there's always a chance of a very dangerous mistake," says Ira Jersey, director of US interest rate strategy at Credit Suisse.

He expects the treasury to run out of cash on or about October 24th.

As it stands, the treasury has stated that its borrowing authority will be exhausted by October 17th, leaving it with about $30 billion to pay its bills.– (Copyright The Financial Times Limited 2013)