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Debt Gridlock! Wall Street on Edge as Default & Downgrade Loom

Financial markets have ignored the U.S. debt debate for long enough, and today we're seeing the first signs that failure to reach a deal on Capitol Hill will not be well-received.

Wall Street is watching as debt talks hit the skids again over the weekend. To be clear, there are two debates that the street needs resolution on: Raising the $14.3 Trillion debt ceiling by August 2nd, and agreeing on a package of spending cuts. Both conversations between Democrats and Republicans now seem as far from compromise as ever.

Government spending cuts must be deep enough to slow our skyrocketing debt-to-GDP ratio to avoid a downgrade of our nation's AAA credit rating according to Dan Clifton, Head of Policy Research at Strategas. America is in a fight to stave off default and a credit downgrade.

"Just a few years ago we had a 30% debt-to-GDP ratio that's going to be 70% this year, and it's quickly moving up to that danger range of 85 — 90%. So S&P has been very much warning that not only do you have to raise the debt ceiling to insure that interest payments are made, but you also have to start getting your fiscal situation under control with a package of about $4 Trillion (in cuts). And so there's two types of downgrades sitting on the horizon," warns Clifton. (Note: Greece's debt-to-GDP ratio is 143%!)

As Jeff Macke points out, the ratings agencies - Moody's and Standard & Poors - are finally getting it right by warning that BOTH raising the debt ceiling and cuts must take place (and he's certainly not one to praise our debt raters as we learned earlier this month on Breakout)!

Not everyone sees the debt-to-GDP ratio as alarming. But this is where the point of contention exists among lawmakers. This is where austerity may finally enter America.

Investors are worried and Clifton says they're asking questions about what will bring on a downgrade. If we cut below $4 Trillion in spending now, will we still be downgraded?

Clifton says, "there's a great degree of uncertainty around that. If you do get a downgrade, think of the impact that will have. You'll also be downgrading a lot of State and local governments… There's pretty wide implications if we get there."

So, hope for the best, prepare for the worst.

Macke says "if we do get a rating downgrade, all the credit in the world is going to price differently because of that; because all the credit starts from the safest risk-free assets and works backwards into the risky ones."

So which sectors will take a hit?

For starters, it would hit housing and any market dependent on credit. Clifton says "you have a number of sectors that can be getting hit from the credit downgrade and hit from the austerity… There's a discretionary spending cap that would go into place."

Basically all sectors that fall under discretionary spending (spending allocated at lawmakers' discretion) could be negatively impacted, "whether that's Transportation, whether that's Education, whether that's Defense, whether that's Healthcare, it's all going to have to fight for that smaller level of appropriation," says Clifton.

While Washington's banter at times sounds childlike -- who walked out on who, etc.-- there is a lot at stake for Americans. We are not in the midst of a minor debate here. And while an August 3rd sans debt deal will not bring financial armageddeon, we are in a battle to save our fiscal integrity.

Can DC save the day? Let us know what you think in the comments section below.