15 Oct 2013 Uneasy Times

These are difficult times for Americans as we watch in disbelief our government’s continued dysfunctionality in the face of impending crisis. The rising shrill of the media and political jabs only make matters worse. We wanted to share some facts we hope will assuage fears and put the current situation in a more realistic context.

First, the government shutdown is a difficult situation for 400,000 government workers who are not getting paid. However, beyond them and those depending upon their services, the shutdown is not expected to have significant impact on our economy, and even less impact on the stock market. Economists expect a range of reduction in our nation’s fourth quarter Gross Domestic Product of between .25% and .5%.

While these amounts are large relative to the anemic growth we have experienced of late, the next quarter’s GDP might easily make them up. On the other hand, stock investors are perversely encouraged by the shutdown as a slightly slowing in the economy only strengthens assumptions that the Federal Reserve will not taper its money-pumping QE3 program any time soon.

Now for the debt ceiling. Failing to raise the debt ceiling does not mean the US government will necessarily default on its obligations. The fiscal 2013 debt service for the twelve months ending September 30 will be somewhere around $420 billion according to the Bureau of Fiscal Service. IRS revenues for the calendar 2012 tax year are projected to be around $2.3 trillion. It is true the Treasury will have to prioritize payments (something he has said he will not do so far), but the Secretary of the Treasury WILL pay all Treasury obligations as he is obliged legally to do so,  as is his boss the President. Some federal agency payments could be held up in that scenario, but it would avert default on the nation’s debt.

There are other reasons to be confident the Treasury will not miss any payments. The shortest Treasury obligations, hence those first to default, are known as overnight repurchase agreements or repo’s. There are trillions invested in repos worldwide by banks that use them as collateral for their short-term loans. Large banks the world over use Treasuries as a significant portion of their reserves. If Treasuries were to default causing a significant drop in value, then 2008 would compare to that event as ripple on a pond does to a tsunami.

Markets have shown relatively little angst so far. Stocks as measured by the Total US Stock Index is actually even with its close on October 1st, the day the shutdown began. Treasuries as measured by the 7-10 year index are down in price .5%, hardly a sign of panic. The yield spread between the 10-year US Treasury note and the German 10 year bond referred to as the “Bund” also flashes no warnings.

Two of the nation’s three ratings services remain comfortable with their positions so far. Moody’s and Standard & Poor’s have stable outlooks on their US ratings. John Piecuch of S&P reiterated yesterday in an e-mail to Bloomberg that the firm’s AA+ ranking already “incorporates the current level of discord” in Washington.

Fitch Ratings just announced they had placed US debt ‘rating watch negative’ saying “the political brinkmanship and reduced financing flexibility could increase the risk of a US default.” However, Fitch reiterated that it expects the debt ceiling will be raised.

We understand the concerns and worries these times bring. We hope that the facts presented help offset, to some degree, the overwhelmingly pessimistic tone blasting from the news outlets. While personally optimistic in the outcome, we do not speculate professionally one way or the other with your wealth. Your portfolios are designed to withstand severe market disruptions and our ongoing stress-testing ensures confidence that your short and long-term needs will be met.

As always, please call us with any questions or concerns.