As the impasse in Washington drags closer to the Thursday debt ceiling deadline, the wait-and-see approach adopted by many Americans has had little effect on the stock market. Government entities haven’t been as fortunate. Furloughed workers and the closing of agencies, including the Energy Information Administration (EIA), are feeling the heat from the bitter political standoff. Traders expressed optimism at a truce as stocks gained over the past week, but issues loom if the stalemate is not solved shortly.
Russ Koesterich, Chief Investment Strategist for BlackRock, says the failure to reach an agreement over the recent weekend is disappointing. However, he expects some sort of patchwork deal will be implemented to extend the October 17, 2013, deadline, saying “limited and piecemeal deals” aren’t convincing enough for traders. “In the near-term, any budget agreement would be viewed as a positive, but if the best Washington can do is a series of short-term extensions, there will be an economic price to be paid.”
Koesterich explained government dysfunction has a trickle-down effect to the markets in his note on October 10, 2013. In short, he says political uncertainty makes businesses less inclined to spend and undermines investor confidence. Such factors strain consumption because of uncertainty over tax and regulatory policies.
Energy markets were effectively hamstrung on October 11, 2013, as the EIA closed its doors indefinitely citing a “lapse in appropriations.” According to the site, all reports are ceased until further notice. Inventory reports on crude oil and natural gas will not be released on their respective dates, and other government arms, including the Department of Labor and the Department of Agriculture will not produce their monthly reports as planned. Drilling permits have also been halted until further notice.
On a global scale, the approaching debt ceiling deadline extends far beyond U.S. government agencies. Christine Lagarde, managing director of the International Monetary Fund, said the potential failure to make scheduled payments to investors could have serious consequences. “It would mean massive disruption the world over. And we would be at risk of tipping yet again into a recession,” she said in an interview on NBC’s “Meet the Press.”
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Overseas, energy markets are shaky with the unsolved issues involving the world’s current leading oil importer and estimated top energy producer. Europe is still in an economic recovery of its own, and Mark Wall, the co-leader of European economics for Deutsche Bank, believes a default in the U.S. would be “most unwelcome.” He said: ‘Europe has reached a position to start a recovery but it’s very fragile, very uneven, and expectations point to vulnerability for few years as it gets its house in order… The U.S. is Europe’s second biggest trading partner, and there is a strong degree of correlation with U.S. financial sector.”
As Bloomberg explains, a default would weaken the US dollar, portray our market as incompetent, and kill economic recovery from its forced spending cuts. Furthermore, U.S. treasury bonds are global financial system pillars. The article says: “Their yields serve as benchmarks for interest rates on mortgages and corporate bonds. Securities dealers in the U.S. hold some $1.9 trillion in Treasuries as collateral on loans to hedge funds, banks and other financial companies. Mutual funds, pension plans and corporations rely on interest payments from Treasuries to meet their obligations to investors, retirees and workers.”
Therefore, the ripple-effect from treasury bonds would be felt in citizens’ bank accounts. In 1979, a Treasury-bond default induced from a technical glitch hiked interest rates up 0.6% and increased the U.S. government’s borrowing costs by $12 billion a year. Today, a rise of just 1% would increase the government’s costs by $120 billion a year.
A weakened dollar would increase the price involved to import oil, so major U.S. exporters watch the debt showdown with great interest. OPEC production recently dipped to a two-year low despite the consistently high numbers from Saudi Arabia. Turmoil in several countries, including Iraq, Libya, and the embargo on Iran, contributed to the drop. The various difficulties only add to the cost of business in foreign countries, ultimately discouraging future operations. Investors have actually wondered aloud about energy independence in North America, as covered in a recent OAG 360® article.
Nigeria, in particular, would receive a big blow to its energy sector if the U.S. is forced to curtail on expensive imports. Nigeria’s export to the U.S. halved in 2012 and has fallen further in 2013, but EIA numbers claimed Nigeria still exported as much as 31 MMBO to the U.S. in Q1’13. The numbers could be much higher if not for theft and destruction to its oil pipelines. In fact, a study by UK-based Chatham House estimates the problems cost the country as much as 100 MBOPD. Declining production rates forced Nigeria to increase its tax rates, a move obviously not well received with current operators, including Royal Dutch Shell, (ticker: RDS.B), Chevron (ticker: CVX), and Exxon Mobil (ticker: XOM).
Early news from today showed no real progress. House Speaker John Boehner spoke briefly in the morning, but said no decisions have been made. The government shutdown, now in its 16th day, is the third longest in U.S. history. According to the Washington Post, the debt ceiling has been raised 42 times since 1980, and the total debt has climbed to $16.7 trillion in August 2013 from $13.9 trillion in Q1’09, an increase of 20%. Debt as a percentage of GDP has climbed 22.5%, according to information compiled by EnerCom, Inc. Now, the two sides in Washington sit entrenched in their decisions, waiting to call the other’s bluff. In the meantime, the markets in New York and around the world wait on the outcome.
Russ Koesterich of BlackRock says it’s time for investors to look abroad. “We believe the prevailing environment should be a reason for investors (particularly those who are overweight in U.S. stocks) to move more of their assets into international equities. International stocks are less expensive than U.S. markets (and thus offer more value), and it is becoming increasingly clear that the U.S. is no longer the only safe haven in the global markets.”
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