Over the weekend, overseas markets reeled with the possibility that the U.S. government might shut down as it entered its new fiscal year on October 1st without a budget. On Monday night the unthinkable happened: the shutdown actually did happen. But the sun rose on Tuesday morning and, improbably, the markets were higher.
The shutdown directly affected some people, ranging from low-income people who rely on assistance to tourists at National Parks, but the financial centers decided they would be relatively unaffected. In fact, Bloomberg pointed out that historically the S&P has risen an average 11% in the twelve months following a shutdown, compared to an average 9% in years when there wasn’t a shutdown.
A much more serious deadline looms on October 17th, when the national debt ceiling must be raised or the government will theoretically start defaulting on its obligations—including U.S. Treasury notes, traditionally the last refuge of safe money. As with the budget crisis, the two sides are expected to stay at a standstill until the last minute before approving an increase.
The Financial Times has posted an interesting hypothesis by RBC Capital Markets, about why “crossing the debt ceiling would be catastrophic.” The full article is on a private site, but in brief the reason a default would be so dire is that markets have no mechanism to identify and trade defaulted vs. non-defaulted obligations so the entire system would freeze up.
“The Treasury’s systems do not clearly mark what scheduled payments are for what reasons, so it is impractical to try to prioritize payments. And clearing systems like Fedwire do not allow defaulted securities to flow, so the system would seize. In order for the clearing systems to work, the Treasury would need to notify the market of a default almost a day before the default happened (to give everyone time to modify payments), and that is not going to happen because the Treasury will not want to declare default while Congress still has time to pass a bill.”
The FT is a London paper, so its columnists regard all of this as one more example of U.S. craziness. Yet if a default does happen, markets and economies around the world would face serious disruption. To quote another Brit, Oliver Cromwell, now is a good time to “keep your powder dry” and stay alert and ready to respond quickly to market conditions. Online Trading Academy students know the best opportunities are found in volatile markets, and that’s exactly what we may face in the weeks ahead.