The federal government reopened for business on October 17th after being "shutdown" since September 30th. Of course during that period many "essential" government services continued and some that were not considered essential at the beginning, became so as the shutdown lengthened. While the shutdown debate merely exacerbated an already existing polarization, the debt markets paid little heed to the Washington antics. The GOP gambled that removing funding for the Patient Protection and Affordable Care Act was their ticket to a leaner budget. The Democrats held serve and now government has merely postponed the debate.
The other noise coming from Washington centered on the debt ceiling and default. Everyone felt compelled to weigh in on the debt ceiling debate and the general consensus was that defaulting, or even risking it, was irresponsible. Truer words have not been spoken but how likely was a default and what did the markets have to say about it?
The attached figure illustrates how the market felt about the shutdown and the risk of default. If default had truly been a risk or an outcome, the debt markets would have fallen faster than Felix Baumgartner after his jump from the Red Bull balloon. The top left of the figure shows what 10-year Treasury Notes did during the shutdown and the bottom left illustrates the same for 30-year Treasury Bonds. Neither market appeared rattled by the supposed risk of default. Both merely continued their small bear market rally. What about the equity markets? The Dow Jones Utilities (top right) showed a slight increase during the shutdown. The Dow Jones Industrials (bottom right) fell for a few days before rebounding sharply.
There was no doubting the outcome of the Washington debate. The government would reopen and the debt ceiling would increase and consequently there would be no default. Raising the debt ceiling, presently, is a frictionless exercise. Why? Look at what the debt markets are telling us. Despite an increase long-term interest rates since last year, rates still remain historically low. This means the cost of servicing debt remains at some level, rather manageable. There is no pain felt by raising the ceiling. In fact, I saw an article the other day suggesting that the debt ceiling should be eliminated.
When the markets speak, and they will, raising the debt ceiling will elicit serious debate. At that point, it will not be a frictionless exercise and the Wizards will have to impose real pain on their subjects.
Jim Mosquera is the author of Escaping Oz: Protecting your wealth during the financial crisis.