Today's Coming Crisis Movie

Tuesday, July 26, 2011

Market Scenarios After the Debt Ceiling Debate is Over

All eyes remain on the debt ceiling debate. While glacial like progress continues to be made, the probability still remains high that an agreement will be reached by the final hour. With this in mind, it is worthwhile to increasingly focus on how investment markets including stocks, bonds and gold are likely to respond once the debt ceiling issue is finally behind us. While the immediate response is likely more straightforward, the market may then find itself on several different challenging paths in the months ahead depending on how the legislation finally comes down.

The initial reaction upon a final debt ceiling deal is likely to be a euphoric sigh of relief. Stocks will likely seize the opportunity to take off on another rally. And assuming stocks follow the pattern shown during our most recent brushes with crisis, we’ll most likely see this rally begin to take off anywhere between 24 to 48 hours before we have the all clear that a deal is done. This initial response in stocks is understandable, as the resolution of the debt ceiling debate eliminates a major risk that is currently overhanging the market. The next steps for stocks after this expected initial burst may not be so positive, however, but more on that in a minute.

As for bonds and Treasuries in particular, they may catch an initial bid once a deal is done, but yields are already so low that it’s equally probable that they may trade flat or perhaps even sell off as investors take off the safety trade and venture back out into risk assets like stocks.

Finally, gold is likely to sell off in the midst of any debt ceiling deal. Gold has performed exceedingly well in recent days supported in part by investors seeking a hard asset safe haven from all of the uncertainty brewed up in U.S. and global investment markets by the ongoing debate. The fact that gold is lingering near overbought levels on a technical basis further supports the idea that a short-term breather may soon be in store.

But the initial response is far from the prolonged market reaction once we begin to move beyond the current debt ceiling debate. And a key to this more extended response is what is decided upon in the final deal. (more)