Markets Have Oddly Calm Reaction To Debt Debate

The Republican House and the administration have not come any closer to legislation to increase the debt cap than they were last week, but the markets have barely reacted at all.

Asia markets were down 0.5% to 0.7%. The major European indices were down even less in most cases. The U.S. markets may have a similarly muted reaction today.

Investors have only a few reasons not to sell down equities in the face of a potential government default, which is only eight days away. One is that Wall St. does not want to dump shares in a plunging market only to find that a last minute compromise brings stocks right back to where they are now. A panic sale is often one done at a large loss.

Another reason is that investors could believe a default is only a default on paper. The government may be effectively closed for a few days as it was when a similar political battle took place in 1995. Congress and the White House realized then that weeks of debate would indeed cause long term economic damage. Once that was clear, a compromise was reached quickly. But Clinton and Congress were right. The world did not collapse when they could not meet the deadline.

Politicians and investors alike may also have decided that a downgrade of U.S. debt by Moody’s, Standard & Poor’s, and Fitch will not mean much. Debt issued by the U.S. will still be considered among the safest in the world. The interest rates that the American government pays will stay very low. The fear of a sharp rise in what the Treasury will have to offer on U.S. paper will barely go up at all. Investors, in essence, will reject the idea that American sovereign debt is any more or less risky than before. There is certainly precedent, even if it is among corporate debt. Wall St. did not care one bit when Warren Buffett’s Berkshire Hathaway (NYSE: BRK) was downgraded from Aaa. Buffett was still Buffett and the bond markets supported the overall strength of his businesses over credit agency opinions.

The reaction to the debt cap debate may not roil the markets at all. August 2 may not effect the value of equities much. Investors may look at a brief default as a small bump in the economic road. The dire warnings will not have meant a thing.

Douglas A. McIntyre