The contentious debate in Washington concerning the debt ceiling has already had profound consequences for the economy of the United States, effects that will likely be felt for years to come as the country attempts to recover from the credit crisis that paralyzed the global financial system in 2008.
Wall Street had been following the negotiations closely for months, clearly concerned about the lack of compromise but ultimately expecting a deal to be completed by the August 2 deadline. As it turned out, an agreement was reached just hours before the government would have been forced to default on its debt obligations.
However, the news of an agreement did little to assuage the fears of investors concerning the continued weakness in the global economy, driving down the Dow Jones Industrial Average more than 500 points on Thursday, its worst loss on a singe day in more than two years.
The consensus has been that the agreement reached over the debt ceiling between Democrats and Republicans is insufficient to deal with the long-term structural problems of the federal budget, especially as it concerns the future course of entitlement spending. Given this uncertainty, investors have been reluctant to invest their money, afraid that future actions taken by the government could have deleterious effects on their portfolios.
The move towards austerity measures may also depress demand throughout the economy, estimated by some economists to be as much as 1.5 percent of GDP. This is a huge decrease for an economy that only grew at 1.3 percent last quarter and suffers from 9.1 percent unemployment.
In addition to the retractionary fiscal policy that could seriously dampen corporate profits, the debt ceiling debate was the first time the stability of the American economic system was in doubt. Treasury bonds have long been considered the safest investment in the global economy, a safe-haven to which investors flock in uncertain economic climates. This was because the American government was considered the most reliable debtor in the world.
Thanks to this perception, investors were willing to lend money to the government for very low interest rates. These low interest rates have had a very stimulative impact on the economy. However, if the United States is no longer considered a safe investment, interest rates on its bonds could increase considerably, making the debt more difficult to service, exacerbating the crisis in a never-ending spiral of debt.
For this reason, the recent downgrade of America’s credit rating from AAA status by Standard & Poor’s is very serious. If investors interpret this as a sign that American is becoming too unstable, they may indeed flee Treasuries and choke off any recovery before it can even get started.
Of course, there has not been enough time yet to determine the full impact of S&P’s move on government debt. As of this weekend, the yield on 10-year Treasuries is only 2.6 percent, a very low level thanks to the desire of investors to avoid risk in this environment. It may end up being the case that the credit rating downgrade does little to change the opinion of Treasuries as a safe holding, especially considering the fact that the other two rating agencies, Moody’s and Fitch, have continued to give the United States its highest rating.
However, given the uncertain economic outlook and the rising debt levels of the government, day traders can expect significant volatility in the months ahead. Most indicators continue to suggest that the economic recovery will remain weak as long as credit remains as tight as it has been. In short, day traders need to be cautious and look for evidence about the future direction of the economy.
Start now by registering to Stocktipr.com for the best latest stock tips!
Nicolas
