Why the stock market “joker” isn’t Evergrande, it’s Washington


The potential for another flirtation with a US government default via a debt ceiling confrontation is helping to increase “political uncertainty,” analysts noted on Wednesday.

The good news is that growing uncertainty has always been a buying opportunity, according to a senior Wall Street technician.

“We think this will prove a buyable correction in an uptrend, but we don’t see the wild card being China, but rather Washington,” Jeff deGraaf, founder of Renaissance Macro Research, wrote in a note.

Stocks were gaining ground on Wednesday, with the S&P 500 SPX,
+ 1.21%
up 1% and the Dow Jones Industrial Average DJIA,
+1.34%
up 382 points, or 1.1%, ahead of a Federal Reserve policy decision expected at 2 p.m. EST. Stocks were trying to shake off a so far modest pullback that saw the S&P 500 SPX,
+ 1.21%
down 4% from its record close on September 2.

Renaissance macro research


DeGraaf highlighted the graph above, following the US Economic Policy Uncertainty Index, designed by economists Scott Baker of Northwestern University, Nick Bloom of Stanford University and Steven Davis. from the University of Chicago. It draws on research results from 10 major US newspapers, Congressional Budget Office reports that compile tax code provisions to expire in the next 10 years, and the Philadelphia Fed survey of professional forecasters. .

As political uncertainty “began to migrate to the markets, politicians
will often push things to the limit to see who blinks and get the upper hand, ”he wrote.

While concerns about a possible government shutdown in October and the debt ceiling are at the forefront, uncertainty is also on the rise regarding President Joe Biden’s agenda, including his infrastructure spending proposals and social protection.

Renaissance Macro Research sees Republicans in Congress holding the strongest cards, which may allow them to force the issue, deGraaf said, noting that the index has yet to jump to the top decile (see bottom part of the chart), which is generally a bullish signal when it comes to the forward returns of the S&P 500 Index.

“If your hands are strong enough to hold, there are plenty of green lights to spin the wheels, but don’t be surprised to see more leaks planted and unfavorable headlines before this is resolved,” he said. -he declares.

Outside the frame: Evergrande crisis and US debt ceiling showdown could give equity investors a buying opportunity

The Democratic-controlled House on Tuesday night approved legislation that would keep the government funded, suspend the federal debt limit and provide disaster and refugee relief, staging a showdown with Senate Republicans who oppose the package.

The federal government will face a shutdown on September 30, the end of the fiscal year, if a funding measure is not approved. A more serious threat surrounds the debt ceiling, which the government could reach at some point in October unless it is raised or suspended. Inaction risks the United States defaulting on its debt.

At least 10 Senate Republicans are expected to vote in favor of the measure to get it the required qualified majority. Kentucky Senate Minority Leader Mitch McConnell, the highest House Republican, insisted the debt ceiling be raised only with Democrat backing, citing opposition to a draft 3-month spending plan 500 billion dollars.

Democrats have refused to tie an increase in the debt ceiling to this spending plan, which they intend to push through in the Senate using a process known as reconciliation, which requires a simple majority. Top Democrats have insisted that lifting the debt limit must be a bipartisan endeavor.

A decision to raise or suspend the debt ceiling, averting a potential default, remains the basic expectation, but fears that collapsing legislation could lead to an incident are on the rise.

Moody’s Analytics economists warned on Tuesday that a default would cause long-term damage to the economy and wreak havoc on global financial markets.

The Tell: Washington “plays dangerous game with debt limit” and “Americans would pay for default for generations, says Moody’s Zandi

Concerns about a possible default by Chinese real estate giant Evergrande sparked a sharp sell-off on Monday. Those concerns have since faded as investors less concerned about the potential fallout that could threaten the Chinese or global financial system.

Read: China Evergrande’s Frankfurt-listed shares jump on subsidiary’s promise to pay

Also see: Will Evergrande be China’s “Lehman Moment”? Wall Street says no

Meanwhile, memories of the last two debt ceiling confrontations, in 2011 and 2013, remain fresh. The 2011 crisis saw Standard & Poor’s, for the first time, lower the US long-term credit rating from AAA to AA +.

Another downgrade cannot be ruled out, even if the US Treasury Department avoids default but does not honor other obligations, economists at Oxford Economics wrote in a note Wednesday. They recalled that the 2011 episode also saw a peak in volatility, as measured by the Cboe VIX volatility index,
-12.56%,
and a 10% drop in stock prices, although the two shocks quickly reversed once the debt ceiling was lifted.

Yet investors “cannot ignore the uncertainty factor and the spillover effects on private sector activity,” they wrote.

Nervousness is already apparent in the short-term treasury bill market, with rates rising on bonds maturing in the second half of October, analysts noted.

Concerns about a possible government shutdown and the debt limit could also cloud the deliberations of Federal Reserve policymakers, who are expected to conclude a two-day policy meeting on Wednesday afternoon. Investors will be looking for clues as to when the Fed will start cutting back on its monthly bond purchases.

The Fed will issue a policy statement at 2:00 p.m. EST, followed by President Jerome Powell’s press conference at 2:30 p.m. ET.

“We believe President Jerome Powell will need to maintain his accommodative stance, saying the reduction is imminent, but remaining vague on the details,” said Greg Valliere, chief US policy strategist at AGF Investments.

“In a world without government closures or threats of default, a reduction by the end of the fall would be certain, but until fiscal policy is clear the Fed may have to wait,” he said. he said in a note on Wednesday.

Read: With Fed officials divided on outlook, Powell seeks compromise reduction plan

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