Could be end of 17 year shutdown drought

At the close of business today, the ASX will log its biggest quarter gain since the third quarter of 2009.

It will be at the highest level since June 2008 and will see small caps logging some of the strongest capital inflows and one of their best quarters since the GFC.

We expect plenty of window dressing all the way to the close today being September 30 and it will distort trading. The US had its first losing week since August and lost 1.1% over the period. The ASX however logged its seventh consecutive north print week on Friday and is now up 172 points over the month (+3.51%), making this the second consecutive month the ASX will outperform the S&P (+3.41%), with one day of trading to go.

So what will tomorrow bring to a market that has performed so strongly and one that has completely outperformed its global leads?

Again we are watching Washington and it is looking increasingly likely that a government shutdown is now a ‘certainty’.  When Democratic Senator Richard Durbin, the second in command behind Harry Reid, was asked his thoughts on a government shutdown, his response was stark.

‘Do I think there will be a government shutdown? Yes I’m afraid I do.’

Overnight a second bill was passed through the House that would fund the US public sector for ten weeks starting tomorrow on the condition the Affordable Care Act (Obamacare) is delayed for a full year.

This is where it gets interesting; the Democrats took the ACA act to an election and won, they believe they have a mandate to fund it and have it fully implemented. The likelihood of the Democrats budging on funding to the act is nil. 

So what does it mean for the world’s largest economy if it does move into a shutdown? Estimates put a government shutdown reducing fourth quarter economic growth by 1.4 percentage points. For a country that is looking at tapering monetary policy sometime in the next six months that amount of economic contraction will stay the hands of the FOMC and see unemployment moving in the wrong direction with confident shot to pieces.

What is even more alarming is the prospect of the debt ceiling not being moved. The October 17 deadline is looming large, and if the markets want to watch a gauge of volatility on the debt ceiling the T-Bill maturing on October 24 is a prime gauge. T-Bills are face value titles; they have no not have coupons and therefore face value is all they are worth at maturity. However if the debt ceiling is not passed, the bill’s face value will not be paid; that is a clear risk and a premium for that risk will start to be priced in. If the ceiling isn’t passed the bill will not be paid and the default will be worn by the holder.

Back in 2011 when the last debt ceiling negotiations took place, the August 2011 Treasury bill coming to maturity spiked 25% over two weeks prior.

Therefore the measure of market volatility over the coming month and the clear indication of what the markets believe will be the outcome of debt ceiling negotiations will be illustrated in the trading of the Bill. We would expect to see it climb higher.

With the government shutdown looming, and over 800,000 non-essential staff being possibly laid off tomorrow, the markets will respond violently to this news. The blind optimism over the last month will evaporate and that makes us nervous about the next four weeks trading. Trade is going to shift quickly and sporadically.  

Ahead of the open we are calling the ASX 200 down 35 points to 5272 (-0.67%) as the DOW futures open 101 points lower on the news out of Washington, a 35 point drop would be a solid result considering the expectation for the open in the US. BHP’s ADR is suggesting they will drop 30 cents to $36.06 (-0.82%) however we see this call as modest, and expect a hard fall over the day as futures ramp up. Trade today will be tough as window dressing and macro issues push the ASX in all directions.

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