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Budget Update: Debt Ceiling Market Meltdown Coming Later Rather Than Sooner?
[private][private] – Congressional negotiations on the budget deal will probably go down the wire, with the goal of finishing before the debt limitation is breached on August 2.
– The August 2 deadline can be fudged by Treasury, through a variety of options such as asset sales or selective payment of expenses. Selective payment of expenses could be messy and could lead to a recession if it lasted more than a few weeks.
– So investors may be facing a lingering death scenario for some time as Congress and the White House try to cobble together an agreement.
Failure is an option, however, with disastrous implications for the markets, which could produce another Lehman moment. Even taking two votes to pass the extension (like the situation with the “must-pass” TARP legislation in September 2008), could provoke a short, but sharp seizure in the equity markets. And the McConnell approach to the debt ceiling almost guarantees two votes-which increases the chances of market indigestion.
– However, we think that an agreement will be made, with a smaller package tied to an extension to the end of 2011 or even 2012, leaving the difficult decisions on entitlement reform or tax increases postponed to later in the year or more likely after the November 2012 election.
– That said, a rating downgrade next month is a possibility even if the debt ceiling is extended. The package may fall short of the $4 trillion “grand compromise” which the House Republicans have initially rejected, which at least one rating agency indicated in needed to achieve sufficient medium term consolidation. In that case, the possible market meltdown may came later rather than sooner.
budget_update_debt_limitation_071511[/private][/private]