Debt-Ceiling Stalemate Unacceptable, Say JPMorgan Strategist, BofA Economist

As the clock ticks down to the Aug. 2 deadline in the debt-ceiling stalemate, market players are growing increasingly worried about the possible impact of Washington’s failure to act on the U.S. economy as well as foreign investors.

“The markets are anxious right now but not overly so. Next week will be a different matter,” said Terry Belton, global head of fixed income strategy at JPMorgan Chase, in a Securities Industry and Financial Markets Association (SIFMA) media conference call on Tuesday.

Belton added that the market is currently more concerned about the risk of a U.S. Treasuries rating downgrade from Standard & Poor’s or Moody’s than an outright default on government debt.

“The view of the market is that Congress will figure out how to raise the debt ceiling in time,” he said, noting that an actual missed interest payment would be such an “extreme, catastrophic event,” that the White House won’t allow it to happen. “The big question is if we’ll have the fiscal discipline to make budget cuts without a downgrade.”

Standard & Poor’s has indicated that if the government doesn’t make significant cuts of $3 billion to $4 billion, a downgrade could happen as early as August.

Belton predicted that a rating downgrade to double-A from the United States’ current triple-A could raise interest rates on the benchmark 10-year Treasury note by 5 to 10 basis points in the short term and 60 to 70 basis points over time.

That rise in rates translates to $100 billion going toward higher interest rates and away from goods and services that would help the U.S. economy, Belton said. He added that upcoming Treasury auctions may have to be postponed, and the last time that happened, in 1995, Treasuries cheapened by 25 basis points.

Joining on the call was Mike Hanson, senior U.S. economist at Bank of America Merrill Lynch, who along with Belton refused to answer questions about which political party or branch of government was responsible for the stalemate. Rather, they pointed out that the rating agencies have emphasized the importance of a bipartisan deal to avoid the risk of a potential downgrade.

“There is a risk that we get a situation where the two sides can’t agree,” which would lead to a default, Hanson said. But the greater possibility is that U.S. debt would be downgraded, “which is a far worse scenario.”

Higher interest rates would have a negative ripple effect on a number of markets, Hanson said, including states, industries and government-sponsored enterprises such as Fannie Mae. In addition, he said, U.S. homeowners and consumers and corporate America would face higher borrowing costs.

While the Treasury has the means to avert default without congressional approval, the bigger risk is lost sponsorship from foreign investors.

“If the United States has lost some of its credibility with foreign investors, it makes is harder to get a long-term budget into place,” Hanson said.

Read Bond Experts Warn of Danger of Debt Ceiling ‘Turmoil’ at AdvisorOne.com.