Debt ceiling deadline creeps into single digits

S&P and DOW futures fell on open yesterday after comments made by the Republican Party stating they will use the debt ceiling negotiations to find concessions.

- US shutdown now into its eighth straight day

- Time to the debt ceiling deadline: 9 days

- Market nervousness starts to eventuate

Futures fell around 0.6% on the open and held at this level for the rest of Asian trade. Overnight the S&P closed down 0.64%, with the Chicago VIX index the big winner; hitting 19.7 from 16 on Friday - market nerves are being tested as derivatives start to become attractive.

On the open of the futures this morning, S&P futures fell again, down -1.01%, with the DOW right behind it at -0.98%. Markets are finally waking up to the fact the impasse on Capitol Hill is far from being resolved, the rhetoric is switching to the debt ceiling which is a major market affecter in every asset class.

Effect of US shutdown

The effect is very apparent in Treasury Secretary Jacob Lew’s statements from the last week. He fired a board side at both sides of politics last week with the intention of prompting House members into action – no real movement eventuated.

He has since fired the shot again, and this time with conditions. He made four national TV appearances on Sunday and stated in all four that the administration (Treasury) would only be willing to negotiate after a partial government shutdown comes to an end and the debt ceiling is passed and increased. It is his comment regarding House majority lead John Boehner that will make investors very nervous:

‘I spoke with John Boehner about the budget impasse and he told me he did intend for it to be passed – and it wasn’t,’ Mr Lew said.

‘He is saying the same thing about the debt ceiling.’

Mr Lew’s statements give Capitol Hill nine days to fix the impasse over Continuous Resolution which has led to the shutdown due to differences over the Affordable Care Act (something that has been ‘debated’ since 2009 and the fund debate has raged for nine months.)

The Hill then has to turn its attention to the debt ceiling which is now only a little over a week away. The dangers here are almost unthinkable; although the borrowing authority runs out on October 17, the US still has over $30 billion in cash reverse which is estimated to run out between October 22 and Halloween. Depending on how the Treasury department handles its payments after this, the US will run out of funds and social security, interest payment and healthcare. The economy that has been working inch by inch to return to some form of normality will be gone in an instant.

What is also clear from an Asian-centric point of view is most foreign-owned US debt is settled in Beijing. Some analysts argue that missing one or even two coupon payments will not affect sentiment around holding US debt, and will more than likely be back paid. However, the credit rating of that debt will be under threat, the risk premium in short term debt will skyrocket (now and into the future) and trust will have been broken as the unthinkable scenario will become a possibility.

Beijing will start to assess its positions if bond coupons are unpaid; state-run firms may find lending not forthcoming from the central government and that will lead to slowing of normal trading. Imports into China will slow and the impact on material and cyclical plays alike will see earnings fall further after two years of contraction, particularly here in Australia.

We have been following the T-Bill due on October 24 very closely since the shutdown. It has once again climbed a further six basis points, which coupled with the move in the VIX, suggests trading over the next week is going to be almost one direction until the impasse is resolved.

Ahead of the Australian open

Ahead of the open we are calling the ASX 200 down 24 points to 5138 (-0.46%) while BHP’s ADR is suggesting the stock may recoup some of the losses from the last few days; adding 17 cents to $34.85 (+0.5%) as China returns from its week long national holiday for Golden Week. 

With NSW, Queensland and South Australia back to work after Labour Day holidays, trade volumes should return to normal after its low read of the year yesterday of $2.5 billion (50% below the year-to-date average). However, with the futures pointing down this hard, and more investors back at their desks, the possibility of a sustained sell-off today is strong.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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