Signs of a thaw in the bitter federal standoff emerged Thursday, sending financial markets soaring on hopes a debt-limit hike would happen in time to avoid a potentially disastrous default.
Speaker John Boehner and House Republicans proposed extending the debt limit beyond the Oct. 17 deadline for several weeks in exchange for talks on long-term fiscal issues. GOP leaders met with President Obama, but no deal was struck. The president has said he wants an end to the government shutdown. House Majority Leader Eric Cantor said the talks were "very useful" and would continue. Gus Faucher, a senior economist with PNC Financial Services, said he was encouraged. Neither the Obama administration nor congressional Republicans would engage in talks over such a deal if they didn't believe it had merit, he said. The talks are "window dressing," he said, but as long as they get the debt-limit increase resolved and bring the parties to the table, it's a good sign.
The S&P 500 rose 2.2% Thursday while short-term Treasury bill yields retreated.
But David Kotok, chairman of Cumberland Advisors, called the market response "a fool's rally.
"There is no evidence yet to suggest that we have a durable solution which will bring any stability to this process," he said. "Markets are celebrating form over substance.
Financial markets had taken the debt-ceiling brinksmanship in stride until this week, when stocks sold off, Treasury bill rates spiked and the price of insurance against a government default shot up. But the long-term damage to the economy from the shutdown, and flirtation with default, will be hard to gauge until the dust settles.
The Federal Reserve's decision last month to delay tapering its bond-buying program over fiscal policy concerns now looks prescient, Faucher said, and means tapering won't begin until December or January, "assuming the damage from the past 10 days to the economy is not too bad.
Government Is A Drag
Economic fundamentals, from corporate profitability to household balance sheets, are basically sound, Faucher said.
"Consumers are ready to spend, businesses are ready to invest," he said. "They just need to see growth is stable and strong enough.
An improving economy could help lower the temperature in fu ture debt-ceiling debates, he said. But D.C. squabbling hasn't helped the economy.
"Business investment and consumer spending has been dragged down by this because you just don't know what the federal government is going to be doing." Faucher said.
Kotok also sees head winds. "We have slow growth, low inflation and a gradual recovery. The political shenanigans set that back as well.
The GOP debt-ceiling deal offer came as Treasury Secretary Jack Lew testified before the Senate Finance Committee about the consequences of failing to raise the debt limit.
"Trying to time a debt-limit increase to the last minute could be very dangerous," he said. "If Congress does not act and the U.S. suddenly cannot pay its bills, the repercussions would be serious.
Lew did not answer questions on whether Treasury could prioritize some payments over others.
"It's hard to accept that we're going to have robust growth coming out of the shocks we've had," Kotok said. "We can't use fiscal policy, and monetary policy is exhausted."
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