Home > Uncategorized > 2011/05/19: The Risk from US (and Others’) Fiscal Impasse May Perversely be Greater for Equities Instead of Government Bonds

2011/05/19: The Risk from US (and Others’) Fiscal Impasse May Perversely be Greater for Equities Instead of Government Bonds

There was an excellent recent Financial Times broad perspective by their credit market supremo Gillian Tett on US Tarp program history and real world implications. In addition to a very concise, well-informed view on that, the column was ultimately attempting to illustrate the title claim that “Tarp shows that US can break political deadlock” (insight column, May 13, 2011) through a bit of history and series of well-thought points. Not the least of which is the fact that it usually takes a crisis for US politicians to take obvious necessary steps.

As Winston Churchill once observed, “Americans can always be counted on to do the right thing…after they have exhausted all other possibilities.” In the current circumstances that now applies to not throwing out the baby with the bathwater while addressing daunting fiscal challenges. As both sides of the political divide rapidly shift between accommodation and antagonism, we are not hopeful about a reasonable resolution.

Regardless of how the specific negotiations unfold, the obvious risk would seemingly be to the US government bond market (possibly along with other sovereigns.) Yet, on recent form any problems with the US fiscal reform negotiations have hit equities even more so than govvies.

This is important as we head into the US economic data this morning (Thursday 5/19) after somewhat better than expected Japanese Department Store Sales and UK Retail Sales. As much as that means the US data will be a critical final influence on the week prior to tomorrow’s relative reporting vacuum (with nothing out in the US at all), from the top of next week there is a return to very important European economic indications. On top of that the Greek Debt-Dilemma will also come back into focus next week as well (even if there is not much in the way of market tests from peripheral European government debt auctions.)

As Ms. Tett noted, the cyclical increase in asset prices has been underpinned by ultra-loose monetary policy; which is also now coming to an end. As evidenced by the recent sharp falls in commodity prices, markets will not wait for the official end of the Fed’s QE2 to reflect a reversion to lower risk appetite, even if the Fed seems committed to remaining accommodative overall. And the situation in Greece is illuminating on the degree to which government spending cuts do not always produce the desired fiscal results. Especially so when they are draconian to the degree that many on the far right in theUS are now demanding.

As such, the sort of Brobdingnagian cuts that House Speaker Boehner suggested he would require (trillions instead of billions) as part of raising the US government debt ceiling, or even any deadlock due to extreme difference of opinion, might prove more of a problem for equities and commodities than government bonds.

On recent form, and regardless of the influences which created it, any extended weakness in equities is good for govvies. And the corollary has been equally true: QE2 has been a minor disaster for the very bond markets the Fed keeps telling us it is trying to support. It has also been a boon for equities ever since it was first suggested last August.

The equity market is also the more dominant focus by far for the public at large. That certainly leaves any overt failure there a more likely source of vox populi outrage and concern which might drive Congress to action. In spite of the ultimate implications for the government bond market, contentious fiscal reform discussions along with monetary retrenchment might well support them if indeed that frightens equities and commodities.

[As this is a pure background post, there are no specific Extended Market Implications; the current levels and comments in the Current Rohr Technical Projections – Key Levels & Select Comments should suffice.]

Thanks for your interest.

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