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Thursday
Oct032013

Wall Street Brushes Off Debt-Ceiling, Republicans Beg To Differ, But Default Would be “Catastrophic,” And Nothing Is Priced In

Wall Street is convinced that the government shutdown won’t hurt much unless it drags out too long. And they’re even more convinced that Congress would never be crazy enough to refuse to raise the $16.7 trillion debt ceiling before the out-of-money date, October 17, and thus send the mighty and sole superpower, the biggest debtor of all times, into default.

Stock and bond markets prove it. They’re sanguine. For them, the pissing match in Congress over raising the debt ceiling so that the US Treasury can pay the bills for outlays that Congress itself had mandated is an amusing soap opera. With a predictable end: a solution. Just in time. Followed by a rally.

If they thought that there’d be a realistic chance the debt ceiling might not be raised in time and that the US would default on its obligations, yields would spiral into a dizzying spike, and the Dow might find itself a few thousand points lower.

No way, José.

“We can’t do that,” Millstein & Co. CEO James Millstein told CNBC Wednesday morning. “It would be such an act of irresponsibility on both parties’ parts to put that at risk. So you really can’t imagine it happening.” He recommended that everyone sit down and “find something” that would allow Republicans – caught, as he said, in “a problem of their own making,” namely their quixotic fight against the Affordable Care Act – “to save face and move on.”

Bill Gross, co-Chief Investment Officer of mega bond-fund outfit PIMCO, which is desperately dependent on US Treasuries not collapsing, wasn’t worried about the current shutdown either. He told Bloomberg that if it lasts three weeks, it might lower fourth quarter GDP by a smidgen, but GDP would bounce back as soon as the shutdown is over and checks go out.

And he too was sanguine about the debt ceiling being raised before the out-of-money date. It’s “a delicate dance,” he said, but nothing more. He was sure the dance would end on schedule. “Default? Unimaginable,” he said.

That sums up the thinking on Wall Street; the partial government shutdown is biting some folks here and there, but in the overall scheme of things, it’s not a big deal.

OK, government contractors are starting to squeal about jobs – their way of wading into the debate. United Technologies announced Wednesday evening that it would have to furlough about 4,000 people if the shutdown dragged out, half of them at Sikorsky and the other half at Pratt & Whitney and UTC Aerospace Systems. The inspectors of Defense Contract Management Agency were off, and before work could go on, they’d have to audit and approve defense-related manufacturing processes.

But if this shutdown merged with a refusal by Congress to raise the debt ceiling by October 17? It would never happen, Gross said. They’d get their act together before the 17th – “Oh they will,” he confirmed. And the markets didn’t doubt it.

But what if? Um, they’d form a “category 5 storm as opposed to a category 1 storm,” he said. It would be “catastrophic,” he said. “Unimaginable.”

It would set in motion a complex series of events, he speculated. Equity prices and commodity prices would get hit. There’d be a “drastic movement away from US Treasuries” with a huge spike in yields. “The whole intertwined connectivity of credit markets and equity-related securities would be unwound in a drastic fashion,” he said. “So this is NOT going to happen.”

But even if it did happen, the Treasury Department would not default on the debt, he said. A good thing, since his Total Return Fund was stuffed to the gills with Treasuries. Maybe he was just trying to mollify investors. They’d already yanked $5.4 billion out of the fund in September, the fifth month in a row of outflows, bringing the year-to-date outflow to $28.7 billion, or about 10% of its assets. Maybe he didn’t want to scare off even more investors.

His point: since monthly revenues were about six times monthly interest payments, the Treasury would continue to pay interest and not default on the debt. In other words, his fund would be fine, though there would be “other repercussions.” But the discussion was just hypothetical. He was convinced, “This is NOT going to happen.”

Republicans beg to differ. A CNN/ORC poll asked: “If the debt ceiling is not raised, would you consider that a good thing for the country or a bad thing for the country?” Overall, 38% of the respondents considered it a “good thing” and 56% a “bad thing,” But among Republicans, a majority (52%) considered it a “good thing” and 40% a “bad thing.” And 61% of the Republicans thought that delaying Obamacare was more important than raising the debt ceiling – even though they knew that it would throw the US into default.

A little discrepancy between Wall Street’s unshakable confidence and the voters who put Republicans in charge of the House. But not one iota of that risk has been priced in. Maybe Wall Street is hoping that the Fed would just print the dang money.

“This sort of political brinkmanship is the dominant reason the rating is no longer ‘AAA,’” S&P ratings agency wrote in a research note. It warned that if Congress failed to pass a debt-ceiling hike before the out-of-money date in mid-October, it would cut the U.S. to “selective default.” Read.... S&P Threatens To Cut US Debt To Junk

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