Markets: Cracks in the ceiling

When markets do get nervous about the US debt ceiling standoff, the fallout could be severe.

It appears the state of relations between the U.S. House, the Senate and the White House is frail at best, raising concerns about the outlook for a debt ceiling increase on October 17.

The longer the US government remains in shutdown, the more concerned equity markets should feel.

Although the number of shares trading hands on the ASX 200 has been lower in the past week than the average for the past month, the gains seen suggest investors have forgotten last time the US was faced with the requirement to raise the debt ceiling.

The ASX 200 is trading close to fair value, suggesting there is no race to be buying equities in what could mark the onset of extreme volatility. 

We haven’t yet seen the capitulation that hit markets in August 2011 as the debt ceiling limit approached. But that doesn’t mean it isn’t coming.

In singe days, as much as 4 per cent was wiped from our local index in response to US dramas, leaving investors reeling.

You can’t help but think when markets finally get nervous, the outcome is going to be more severe in the face of recent market gains.

Although the Dow Jones has fallen for the past two sessions, the decline has been marginal.  It is almost like the market has complete disregard for the potential outcome and is demanding the debt ceiling be raised.

There has been no shortage of commentary about the dramas absorbing US politics and markets. Respected commentators Michael Lewis, the financial journalist and author, and Bill Gross offer a punishing insight into the state of affairs.

Days before the September meeting when markets believed it was a foregone conclusion the Fed would begin tapering, Gross tweeted he expected the Fed to “tinker rather than taper” (Expect US rates to stay low for a long, long, time, October 4). While the Fed cited an uncertain economy, perhaps they were concerned about the upcoming budget and impact it would have on the economy and markets.

Almost seconding this, Michael Lewis wrote in a recent note to investors that the Federal Reserve’s use of quantitative easing was an insurance program against any fiscal policy errors they believe Congress might make. This would make quantitative easing an extremely expensive insurance premium for worries coming from Washington. And it also means it isn’t going anywhere anytime soon.

When you look at the problems facing the US, both political and economic, the US economy is more fragile than the market gives it credit for.

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