Wall Street betting on last-minute debt deal

15:11, July 28, 2011      

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With no political deal in Washington on raising the U.S. debt limit just days before a crucial deadline, investors are increasingly worried about a downgrade of the country's top-notch credit rating, or even an actual governmnent debt default.

The U.S. Treasury Department has said the Congress must act before Aug.2 to avoid a catostropic default. With the dealine drawing close fast,political wranggling in Washington has rattled Wall Street, though not in a way some pessimists had imagined, as many still believe an 11th-hour deal is still possible.

U.S. stocks traded lower in two consecutive sessions after debt ceiling talks between President Barack Obama and House Speaker John Boehner fell apart over the weekend, but no severe sell-offs have been seen in the market.

Both the blue-chip Dow Jones Industrial Average and the broader S&P 500 were less than 2.5 percent below their April 29 highs and still on track for their first monthly gains since April, partly because investors believe a deal not only will, but has to be reached before the deadline.

The Chicago Board Options Exchange Volatility Index, or VIX, which is known as the "fear gauge," rose as much as 10.6 percent Monday, but the current reading of 19.26 remains below its long-term average of around 20.

Even more assuring, U.S. government bond prices edged up Tuesday even as negotiations over raising the borrowing limit remain at an impasse.

Not only an auction of two-year notes met strong demand Tuesday, the price of the benchmark 10-year Treasury note inched higher, dragging down the yield to 2.95 percent from 3 percent, close to a historic low.

"The fact that the markets are not getting hit right now, I think it's showing that investors feel that we are not in that panic mode just yet, but have to wait and see," said Jonathan Corpina, senior managing partner at Meridian Equity Partners. "We are coming really down to the deadline, and as hours pass, it's really gonna make an effect on the markets."

Alan Valdes, chairman of the U.S. investment banking service group Huade International and a veteran trader with more than 33 years of experience at the New York Stock Exchange, believed that the talks in Washington are more political than economic.

"I believe they will reach some kind of agreement on August 1. I don't think they have the guts to let the United States default because they know how much is at stake, and they will probably come to some sort of an 11th-hour agreement," Valdes told Xinhua.

Art Cashin, director of floor operations for UBS Financial Services, said, "If you poll 98 percent of the people down here, they don't think anyone in government on either side will be that foolish."

While hoping for the best, investors are also preparing for a possible setback as quite a number of them see more volatility down the road no matter what happens in Washington.

Gold, which is considered a safe-haven asset, has benefited a lot from the ongoing uncertainty. Gold for August delivery, the contract with the most volume, ended at another closing high of 1,616.80 U.S. dollars per ounce on the New York Mercantile Exchange, as investors are reallocating more funds to gold from other assets such as the stocks.

Valdes believed the worst-case scenario, in which the United States defaults on its debt, is unlikely to happen. However, a downgrade of its top-notch AAA credit rating to AA will not be a surprise if the debt ceiling is raised but without a plan large enough to address the long-term deficit problem.

"The debt limit is meaningless, what really matters is the debt-GDP ratio. So what they are doing is just kicking the can down the road," Valdes told Xinhua.

"With the government cutting spending, we'll see tremendous layoffs and a longer time of slow recovery. That's the real problem, and the market will be very volatile," he said.

If a default, currently regarded as a "very low probability event" by virtually all of the Wall Street community, really occurs, the financial market will suffer greatly.

"Just from a psychological point of view, something is gonna happen," Corpina said. "You are gonna see a tremendous wave of ripple effects that is gonna go to other economies, other markets globally."

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