StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

Wall Street Hasn't Been Telling Us The Truth On The Debt Ceiling

20 Jul 2011
Posted by Stan Collender

For weeks, Wall Street has been saying that it was convinced there would be a deal on the debt ceiling in Washington and wasn't at all concerned about the possibility that nothing would get done by the August 2 deadline. There would be a deal, it said, because in the end there's always a deal and everything that we were seeing inside the beltway was nothing more than political theater. As a result, the common assumption was that the prospect for a deal was already priced in to the markets.

Except that we now know for sure that it wasn't.

In response to the news yesterday that the gang of six had finally agreed to a comprehensive deficit reduction plan and the preliminary signal from the White House that the deal could provide the way to avoid a debt ceiling crisis, there was a clear relief rally in both the stock and bond markets. The timing of the rallies was unmistakably associated with the gang of six announcement, and the analysis made it clear that traders were responding to what it considered positive news that was different from what it was expecting.

In other words, the market analysts who have been saying for months that the debt ceiling fight was having no impact on stock prices and interest rates either didn't have a clue or were lying.  The  relief rallies that took place yesterday immediately after the the gang of six plan went public shows that (1) Wall Street was/is indeed very concerned, (2) interest rates absolutely have been higher than they otherwise would have been because of the debt ceiling fight, and (3) completely contrary to what we've been told, interest rates and stock prices will be substantially affected if the debt ceiling isn't raised by August 2.

It also shows that Wall Street is far more concerned that a deal won't be reached than it has been willing to admit.

Very weak analysis, because

Very weak analysis, because you try too hard to sell it. The long-bond rose because of a curve-trade unwind. Why did tens not keep up with bonds if the bond rally was a response to a short-term default risk? Why were fives flat on the day and twos down if what we were seeing was an end to a short-term risk to Treasury payments?

Why, if Treasury is likely to make good on debt market payments and not on others, would the bond rally on news that a debt ceiling deal is more likely? Increased Treasury supply and less risk to the economy is reason to sell Treasuries, not buy them.

There is a very common bit of analytic wisdom which you have violated in your eagerness to prove your point. One day's data doesn't tell you much. Financial journalists will always round up somebody who says the day's market activity was the result of some bit of news or other. The fact that they always do that is reason to doubt their claims, not to validate your own.

Seriously now, you shouldn't even try to write stories like this one. Your expertise is in budget matters.

Stan ignores Greek debt deal in his "analysis"

I agree with YABW, Stan should stick to budget details. Here's another explanation, much more reasonable than Stan's Bartlett-infected hysterics:

Markets are global. Capital is mobile. With the threat of large losses in value on a Greek default looming, Treasuries were the "cleanest dirty shirt" among liquid assets. The Merkel-Sarkozy deal fixes the Greek losses at roughly 20% of par, not as bad as the market expected. At the margin, money flows out of Treasuries and into Euro-denominated government bonds.

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