The Next Worry for Markets: No Deal Yet on US Debt

While Europe has finally come to an agreement on their debt crisis, there is still is no deal reached on the US financial crisis. The national currently has a $15 trillion debt load and many investors are hoping that the deficit panel can agree on a bare minimum of cuts.

By: Jeff Cox
Published: Friday, 28 Oct 2011
CNBC

Wall Street might want to enjoy the rally over Europe's debt agreement while it lasts, because another debt crisis is still looming closer to home.

The euro zone crisis had been recently overshadowing the debates in Washington over how to rein in America's debt, whose rapid growth triggered a downgrade to the US credit rating in August and sparked a market selloff.

But with Europe apparently settled for now, a supercommittee of Democratic and Republican leaders is likely to regain Wall Street's focus, and should the group fail to come up with a debt solution acceptable to ratings agencies, the summertime scenario could play out once again.

"We fear that the so-called 'Super Committee' of both Republicans and Democrats that has been charged with putting for a credible and material deficit reduction program will do nothing of the sort and will end up falling apart because of bilateral bickering," Dennis Gartman, hedge fund manager and author of The Gartman Letter, wrote Friday. "The committee has a Nov. 23 deadline, and from the discussions and rumours thus far there is no chance that anything credible shall be put forth by that date."

Right now, investors are merely hoping that the deficit panel can agree on a bare minimum of cuts to deal with the nation's nearly $15 trillion debt load.

"They're only looking for a trillion in savings," says Keith Springer, president of Springer Financial Advisors in Sacramento, Calif. "They don't do anything unless there's a gun to their head. They'll come through with the bare minimum, which will be a boost to the market and prevent another downgrade."

Not everyone, though, is quite so convinced.

Analysts at Bank of America Merrill Lynch have said in recent days that another credit downgrade, similar to the one from Standard & Poor's that triggered a 500-point one-day selloff in the Dow industrials, is possible before the end of the year.

S&P's move came in reaction to Washington's inability to meet the rating agency's target for deficit reduction. Should the supercommittee come up short — and the indications in the early sessions are not favorable — the good feelings over Europe's crisis resolution could dissipate quickly.

"In many ways, the supercommittee is damned if they do and damned if they don't," says Quincy Krosby, market strategist at Prudential Financial in Newark, N.J. "If they come out with the cuts and it indicates that what we're going through now is just a positive bump and we're going to to back to weakening, there are going to be questions about the growth rate in the country."

Indeed, the U.S. faces much the same debt challenges as Greece, even though the latter and its southern European peers face debt burdens relative to gross domestic product that are much more severe than the situation Washington confronts.

But addressing those burdens requires cutbacks, which in turn could inhibit economic growth. That would come at an especially ticklish time for the U.S., where recent data has indicated that the country may defy predictions for a new recession just two years after the end of the last one.

Despite persistently high unemployment and a flatlining housing market, gross domestic product grew 2.5 percent in the third quarter and earnings have done well for the quarter.

But Europe actually labors under a higher probability of recession, and should cutbacks slow growth dramatically it will be hard to prevent contagion to the U.S.

"While the plans represent a step forward, we suspect that they will soon be viewed in the same way as every other policy response during this crisis — as too little, too late," Jonathan Loyes, at Capital Economics in London, wrote in a note to clients. "We still expect the crisis to prompt a prolonged recession in the euro-zone, further turmoil in global financial markets and, at some point, the end of the euro itself in its current form."

That raises concerns, then, that U.S. investors may get getting too sanguine about a resolution to the euro debt crisis and making large bets — as evidenced by the market surge Thursday — that the crisis is in the rear-view mirror.

Like a football team that had just scored a touchdown and taking turns spiking the football in the end zone, strategists said the only direction for the market was higher.

"This European Union agreement is going to be a game changer," says Gary Hager, president of Integrated Wealth Management in Edison, N.J. "This is huge technically. The market might be a little stretched short-term, but we've clearly broken out of the consolidation to the upside."

Hager believes the market is well on its way to setting a new all-time high that would take it past its 14,198 Dow level in October 2007.

"This is as clear a green light for rising equity values as I've seen since the break in 2008," he says. "This was like a cake that was baked great. This came out of the oven very nicely."

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