@theMarket: Markets Signaling No Debt Default

The only thing that mattered to investors this week was the looming U.S. government debt default. Fortunately, the comments from major players in the debt talks have been largely encouraging. The devil, however, will be in the details.

 

The stated deadline for the passage of raising the debt ceiling is June 1, according to Janet Yellen of the U.S. Treasury Department. Some argue that it is a self-imposed deadline. Depending on several factors, including tax revenues, the U.S. might conceivably stretch its ability to pay its debt as far out as August, but that is no sure thing.

 

In any case, even if the two sides fail to agree on the details there is also the possibility of extending the debt ceiling limit a few weeks for the t's to be crossed and i's dotted. No one is talking about that yet, since Washington deadlines, artificial or otherwise, have the effect of galvanizing politicians to cross the finish line if at all possible.

 

House Speaker Kevin McCarthy said late last week that the House could vote on a debt ceiling deal as soon as this coming week. Both sides have gone out of their way to assure the public that a debt default is not on the table.

 

The discussions are continuing, and the negotiators are keeping the talking points close to the cuff and behind closed doors, which is another positive, in my opinion. The fact that McCarthy is talking directly to two of President Biden's most trusted negotiators is encouraging as well.

 

But every time one side or the other expresses something negative, markets react as they did on Friday when GOP Representative Garret Graves, who is leading negotiations for McCarthy, said "It’s time to press pause because it's just not productive." Market gains evaporated in seconds. Investors should expect more of this volatility next week.

 

Complicating the picture, however, is that both the House and Senate left town on Thursday and the Senate is not expected to be back in session until the last few days of May. There is also a danger that the hardline radical group of Republicans in the House could balk at any compromise hammered out by both sides.

 

In sum, while the markets are betting that a deal will be done on time, the danger is that it won't. If that were to occur, the downside in stocks could be considerable.  

 

The stock market, which has been stuck in a tight trading range for weeks (4,050-4,160), broke above that range and the S&P 500 Index vaulted above the 4,200 level this week. My upside target is still 4,325. Technology, semiconductors, and anything that remotely had something to do with artificial intelligence (AI) continued to lead the markets. 

 

Sectors that had been held back due to the risks associated with the debt ceiling found some strength while your typical safety trade areas such as precious metals, utilities, consumer staples, health care, etc. lost ground.

 

On the Fed front, there seems to be a crack in the monetary mantra that more interest rate hikes are on the way. Several Fed members seem to be advocating for a pause in the rate hikes, while others thought that we still needed at least one more hike. But none of them suggested that a rate cut was on the table any time soon.

 

In the coming week, all eyes will remain focused on Washington. President Biden plans to fly home early from the G7 meeting to shepherd the talks as the clock ticks closer to the deadline. If the politicians can keep control of the narrative and come to a deal, we could see my target met before the end of the month. If not, look out below.