Super Stalemate

Global markets fell Monday, with US stocks down nearly 1.9%, as investors mulled several weekend developments. Market volatility can rarely be tied to any one thing, and Monday was a good example. Moody’s warned of a French downgrade should higher borrowing costs and slower growth persist (another example of raters following markets—not providing much forward-looking analysis). And Spain got a new government—incoming center-right Prime Minister Mariano Rajoy is expected to announce new austerity measures in the coming weeks.

US investors, meanwhile, seemed focused on the home front, where Congress’s budget “super committee” announced it failed to agree on budget cuts. When Congress agreed to raise the debt ceiling in August, it appointed the super committee to slash $1.5 trillion from the budget by November 23. Failing that, $1.2 trillion in cuts over the next 10 years automatically kick in. To meet the deadline, the Congressional Budget Office needed a draft bill by Monday—which came and went.

As we’ve explained though, the deadline doesn’t much matter. It’s arbitrary, set by Congress, which can always reset or remove it. The automatic cuts—which aren’t actually cuts so much as a slower pace of future spending—don’t start until 2013, so there’s ample time to find a workaround. In fact, we’re not sure anyone truly expected the committee to agree now, with so much time to spare—legislators typically run things down to the wire, so it seems natural a deadline with no inherent urgency wasn’t met. Also consider, Congress’s approval rating is a paltry 7%. So maybe 7% of Americans had confidence Congress would reach a palatable deal—93% knew better.

In our view, this turn of events resembles a typical budget showdown—though some posit the background threat of Moody’s or Fitch downgrading the US’s credit rating makes this more problematic. Both have said super committee failure won’t automatically trigger a downgrade but would be considered in their next assessment—so we won’t begin to handicap the likelihood a rating action follows. S&P downgraded the US for similar political reasons after the debt ceiling deal (essentially saying Congress was too divided and took too long, despite the fact there was little remarkable about this year’s iteration of debt ceiling theatrics). If Moody’s and Fitch use similar methods, more downgrades are possible.

But then what? Recall when S&P downgraded the US to AA+, Treasury rates fell—the opposite of what you’d expect if the US were widely viewed as a riskier borrower. Similarly, amid today’s headlines proclaiming a defunct political system is leading the US down a path to insolvency, a US two-year Treasury auction was over four times oversubscribed at near record low rates with particularly strong demand from foreign investors. So it truly seems investors who actually own Treasurys have little concern they’ll be repaid and place little faith in credit ratings agencies’ opinions. And we think that’s about how much faith you should place in them.

We’re not defending politicians’ inaction on this matter, but those expecting politicians to exceed or even meet their expectations are frequently disappointed—today’s news was no exception. Our guess is this becomes campaign fodder for both parties, with each blaming the other for the super committee’s super failure. But it shouldn’t take investors long to look past the political posturing and focus on more positive fundamentals.