Depending on who you talk to, early August will either be a colossal financial disaster, or just another week of good beach weather.
It comes down to whether you think that the Republicans and Democrats in Congress will reach some sort of deal to raise the national debt limit. If so, the Treasury and the Federal Reserve will be able to continue servicing the outstanding debt and sell new bonds; if not, there will be an impasse, impeding the government from selling new debt.
The latter is the worst-case scenario as described by economist Dean Baker, co-director of the Center for Economic and Policy Research in Washington, a liberal think-tank. As he sees it, if such a measure failed to pass, "We'll see the same sort of plunge in the stock markets that we saw when the House voted down the Troubled Assets Relief Program (TARP) the first time back in September of 2008." In that case, he says, "We will see a freeze-up of lending and companies would be forced to dump millions of workers as they could no longer meet their payrolls."
Investors, however, so far seem confident that such a grim scenario is unlikely. They may be gradually pulling out of equities, and shifting away from junk bonds to more highly rated debt, as evidenced by the most recent Morningstar report on May fund flows. But the interest rate on the benchmark 10-year T-bill has barely budged from 3%, where it has been for months, which suggests a general lack of concern.
As Jeffrey Saut, chief investment strategist with Raymond James, says, "The market is telling us that investors think our elected 'nimnods' will come together at the last minute and do what they should have done already by now, and raise the debt ceiling."
Saut predicts that at some point, probably close to the deadline for raising the debt ceiling, Democrats and Republicans will reach a negotiated deal. "You'll see bigger cuts in the federal budget than most people are expecting. They'll throttle back on some entitlement programs. And longer term, you'll see them continue to debase the U.S. dollar. You'll also see taxes go up, and not just on the rich, but on the middle class too, because that will have to happen."
Indeed, most analysts and portfolio strategists in the trenches seem confident that an agreement will be reached before a meltdown occurs like the one described by Baker.
But some still caution that the worst-case scenario can't be ruled out. "Most of my clients think that this is all a political game of chicken, and that there will be a resolution before the so-called deadline," says Jeffrey
Panik, vice president for wealth management at CBS Wealth Management. But he warns, "Anyone who doesn't think that the debt ceiling crisis isn't a risk to portfolios is making a big mistake. The GOP is looking at this politically, and their strategy is not very thought out... The debt ceiling has to be raised, or there could be devaluation of the dollar and soaring T-bill rates. Things could spiral right back to where we were in March 2009 if nothing were done."
Others are less concerned. Steve Kennedy, a Raymond James financial advisor at the Towne Bank in Newport News, says most of his clients think the debt ceiling issue is "just political posturing." He says he tells them his own sense is that it's a political game that will continue "until there's a real crisis, which is the only time people in Washington ever really act."
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