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SocGen On The Three "11th Hour" Debt Ceiling Scenarios, And Their Respective Market Reactions

Tyler Durden's picture





 

As we enter the overnight futures market open, there is still no resolution on the ongoing debt ceiling open question. Which is why we present SocGen's handy summary of the three scenarios that are currently in the running for a consensual resolution, together with the possible market reactions to each. The three plans are the McConnell-Reid plan, which as per latest news is in the frontrunning currently, not least (and probably only) due to the immediate beneficial impact it would have on stocks. The 2nd plan is a large deficit reduction plan, whose primary impact would be a significant drag on GDP. Stocks, and bonds, are likely to both rally on the news of this plan, at least in the short-term until the market realizes that some economic growth is actually necessary for the hopium illusion to continue. Lastly, the worst case outcome is no increase in the debt limit, which, logically, would mean that every illusion collapses and the emperor is finally exposed to be naked.

From SocGen: US debt ceiling scenarios at the 11th hour

We are heading into overtime in the debt ceiling debate. The news flow will be fluid this upcoming week, and as a result markets could be volatile. While a long term deficit reduction plan that is attached to a large increase in the debt ceiling is the ideal outcome, a small increase in the debt ceiling remains the baseline scenario. The Senate could begin moving on the McConnell-Reid plan this week in order to get the debt limit raised before the Aug 2 deadline. Market reaction to the various outcomes could vary with the response to a technical default the most intriguing.

The debt ceiling fiasco is coming down to the wire. There is about a week left to the August 2 deadline in which the Treasury says its accounting trickery will run out and the US will enter into technical default. Parties continue to try to negotiate a long term deficit reduction deal. But reports suggest that the ideological divide remains too wide to close in time to attach a large scale debt deal to an increase in the debt ceiling. We continue to believe that the most likely scenario is a last minute deal to increase the debt ceiling with very little in agreed spending cuts. We have to consider the potential market impact of this outcome as well as two other scenarios, including an increase in the debt ceiling coupled with substantial deficit reduction; and no increase in the debt ceiling.

McConnell-Reid Plan. This is multiple stage plan which sees the debt ceiling increased by $100bn immediately followed by much larger increases in the future which are tied to matching spending cuts. The total debt ceiling increase is said to be $2.5tn. If there is no progress on a long term package, we could see the Senate begin moving on this plan early next week.

Market considerations. We could see a rally in stock markets, as it could remove some of the uncertainty hindering the economic expansion. The University of Michigan confidence survey asks a specific question about government policies and that assessment deteriorated sharply in July. According to our models, if sentiment reverses after the raising of the debt ceiling payroll growth should return toward a 150k-200k range by the fourth quarter.This is only enough to support a snailpaced Fed exit, but it will fall far from the Fed’s easing threshold which remains very high in our view. While stocks may rally, the impact on Treasuries is more uncertain as a small increase in the debt ceiling still keeps the door open to a credit rating downgrade from Standard and Poor’s.

Large Deficit Reduction Plan. There are a number of plans on the table including the $3.7tn package from the “Gang of Six” which includes Senators from both parties. As well, negotiations are ongoing between the White House and Congressional leaders. Time is short and the partisan divide is likely still too great for one of these plans to pass.

Market considerations. The market reaction to news of a grand plan could be similar to the reaction we saw when both stocks and the long bond rallied on the news of the “Gang of Six” plan.

We also have to remember that large scale austerity measures could be a major drag on GDP over the next ten years. Our simulations using the President’s Debt Commission plan showed that in 2013 the cuts could shave 0.4pp to 1.4pp off growth and by 2020 the drag could be even greater, at 1.4pp to 5.1pp. This is illustrated in the fan chart on the previous page. The red line is our baseline forecasts and the grey area is the
range of possibilities for growth if there is a large-scale fiscal austerity package.

This could also mean that expectations of monetary policy may shift. Relative to our central scenario, which sees the overnight rate rising toward 4% by 2015, the austerity scenario sees the Fed leveling off at 2% and pausing afterwards. While some of the fiscal drag will be partially offset by lower bond  yields and a “crowding-in” effect, the Fed will nonetheless have to lean against the wind.

No Increase in the debt limit. We continue to see this risk as very small particularly given the fact that President Obama has sent signals that he would adopt the McConnell Reid plan as the path of last resort. That said, if there were no increase, it would result in the US entering into a technical default and this would be followed by a downgrade to its rating by credit ratings agencies.

Market considerations. Intuitively, we would assume that Treasuries would sell off in the event of a technical default. But there is growing sentiment  that this may not be the case. The sensitivity of equities to the fiscal situation is greater than that of Treasuries. As a result, under a technical default  there could be a large sell off in equities and we could see Treasuries rally as investors flee to safety. It is also worth noting that government spending could contract in the event of a technical default. The contraction would be in the magnitude of 10% of GDP annualized if the stand-off lasts from August to September. This could risk putting the US back into recession; hence an equity sell-off and Treasury rally. Chatter suggests there is growing belief that this is the reaction expected by markets in the case of no increase in the debt ceiling.

 


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Sun, 07/24/2011 - 17:51 | Link to Comment rajat_bhatia
rajat_bhatia's picture

sad

Sun, 07/24/2011 - 17:57 | Link to Comment bankrupt JPM bu...
bankrupt JPM buy silver's picture

So we rally, and the metals get slain..?  Till Friday that is.

Sun, 07/24/2011 - 17:59 | Link to Comment At120
At120's picture

Are you here 24/7?

 

Sun, 07/24/2011 - 19:33 | Link to Comment DeadFred
DeadFred's picture

The government's psyops computers are state of the art and can run 24/7

Sun, 07/24/2011 - 17:52 | Link to Comment bugs_
bugs_'s picture

we may hear them talking about the goldilox default scenario

Sun, 07/24/2011 - 18:11 | Link to Comment Ghordius
Ghordius's picture

Your comment makes me so nostalgic. Ahhh, the Goldilocks!

Sun, 07/24/2011 - 22:54 | Link to Comment eureka
eureka's picture

Yep - and then add some more nostalgia, like "De-Coupling" (this time from reality itself) - and a "Jobless" - not to mention "Homeless" "RECOVERY" - Kudlow is gonna blow and huf and puf - all very nostalgic and topped off with tons of custom ordered Wall Street "Greenshoots".

Sun, 07/24/2011 - 17:54 | Link to Comment Prepared
Prepared's picture

sad, rediculous and pathetic.  This is like watching a slow moving hurricane target our shores.  You know it's coming one way or another.  Bonus time to prep is a good thing. 

Sun, 07/24/2011 - 17:55 | Link to Comment TheGoodDoctor
TheGoodDoctor's picture

14th Amendment Bitchez?

Sun, 07/24/2011 - 17:56 | Link to Comment AldousHuxley
AldousHuxley's picture

how about some austerity in the bankster industry? lay them bankers off and watch the economy take off!

Sun, 07/24/2011 - 17:56 | Link to Comment Bill Hicks
Bill Hicks's picture

"The contraction would be in the magnitude of 10% of GDP annualized if the stand-off lasts from August to September. This could risk putting the US back into recession"

 

Ummm...a 10% drop in GDP is NOT a recession, it's a depression. 

Sun, 07/24/2011 - 17:57 | Link to Comment FunkyMonkeyBoy
FunkyMonkeyBoy's picture

Hey buddy, change your photo to Dennis Leary.

Sun, 07/24/2011 - 18:20 | Link to Comment Franken_Stein
Franken_Stein's picture

 

I love it when people talk to themselves.

Happens to me all the time, too.

 

Sun, 07/24/2011 - 18:21 | Link to Comment Franken_Stein
Franken_Stein's picture

 

He's right.

Listen to this Frankenstein guy and you will become a wise man.

 

Sun, 07/24/2011 - 21:47 | Link to Comment Bill Hicks
Bill Hicks's picture

I'm Bill Hicks...and you're not. 

Sun, 07/24/2011 - 22:50 | Link to Comment oblonsky
oblonsky's picture

not sure if they mean a 10% drop in GDP or a 10% drop from 2% to -8% or from 2% to 1.8%. 

Sun, 07/24/2011 - 17:59 | Link to Comment Ghordius
Ghordius's picture

"We continue to believe that the most likely scenario is a last minute deal to increase the debt ceiling with very little in agreed spending cuts."

Chance: 90%

Markets by then: "priced in"...

Sun, 07/24/2011 - 17:57 | Link to Comment pesamystik
pesamystik's picture

If I lose one god damn dime because the oligarchy failed to perpetuate the status quo another day, I'll be very mad. I want DOW 36,000 NEXT GOD DAMN WEEK. RAIN MONEY DOWN ON ME BEN, RAIN IT DOWN.

Sun, 07/24/2011 - 19:04 | Link to Comment Noah Vail
Noah Vail's picture

Markets will rallly if I pee on my shoe.

Sun, 07/24/2011 - 17:59 | Link to Comment Derpin USA
Derpin USA's picture

This analysis completely ignores the large amount of institutional investors who would be forced to divest of treasuries in the even of a downgrade from AAA.

A rally in Treasuries? I think fucking not.

Sun, 07/24/2011 - 18:04 | Link to Comment Ghordius
Ghordius's picture

Downgrade from AAA? This year?
The Basel rules would force all TBTF to increase their equity.
This would harm banker's bonuses.
Remember who pays Rating Agencies?

Sun, 07/24/2011 - 18:11 | Link to Comment Derpin USA
Derpin USA's picture

An event of default would do that. The article argued that equities might suffer and Treasuries migh gain in the event of a default. I find that to be a very wrong analysis based on what I said previously.

Mon, 07/25/2011 - 01:38 | Link to Comment darkstar7646
darkstar7646's picture

I'd lay odds on "this week".

Sun, 07/24/2011 - 18:29 | Link to Comment snowball777
snowball777's picture

+1

It's not a matter of demand or "flight to safety" in that case. It's black-letter contract law.

Sun, 07/24/2011 - 19:36 | Link to Comment Newtons Lawyer
Newtons Lawyer's picture

Ratings agencies are unlikely to do anything but threaten to downgrade.  Debt service is still a small part of the budget and will be the first priority.  So Treasuries could rally, as well as the dollar.  Equities probably wouldn't fare as well but with Ben around, who can do anything other than guess.

Sun, 07/24/2011 - 17:59 | Link to Comment rubearish10
rubearish10's picture

Well, SPU's are indicated 10 points lower. Better pass something now or else. HLOY CRAP (real sarcasm)

Sun, 07/24/2011 - 17:59 | Link to Comment Captain Benny
Captain Benny's picture

Seems like everyone and their child is thinking that the equities will rally on a debt ceiling increase.  Am I the only one that thinks one of the ratings agencies will finally get some balls and straight up tell it how it is and downgrade the US for kicking the can down the road?

I personally think we'll see commodities rally with any debt ceiling deal, but I can't say I see equities rallying from their already high point.

Sun, 07/24/2011 - 18:08 | Link to Comment Ghordius
Ghordius's picture

Where is your trust in rating agencies coming from?
They will serve their client's interests.

Sun, 07/24/2011 - 18:14 | Link to Comment Captain Benny
Captain Benny's picture

Whose to say that they don't have clients betting big that the US is doing to be downgraded?  I honestly don't expect a downgrade any time soon, but I do expect expect one eventually.  This week I expect more statements trying to scare the populous into thinking a downgrade is imminent.

Sun, 07/24/2011 - 18:08 | Link to Comment TooBearish
TooBearish's picture

Anyone who thinks they will downgrade the US to AA is smoking - S&P and Moodys would lose their cartel status and hafta do some real work - absolutly no chance of a downgrade - move along.

Sun, 07/24/2011 - 18:11 | Link to Comment Everyman
Everyman's picture

"According to our models, if sentiment reverses after the raising of the debt ceiling payroll growth should return toward a 150k-200k range by the fourth quarter."

Your models are asinine then because it does not take into account that the majority of investors, citizens, etc. ALL understand that the "debt ceiling increase" is only for 2-3 months.  Only complete morons pumpertards would make the assumption that this plan "resolution" is a resolution.  What kind of idiots are making these idiotic calls???????

"The market reaction to news of a grand plan could be similar to the reaction we saw when both stocks and the long bond rallied on the news of the “Gang of Six” plan."

AGAIN, you make ASSUMPTIONS you even know "what" is in the plan, and you are taking the word of a bunch of coward liars (congresscritters) that this "fixes" the problem.  Again you are an idiot that aught to get a jalapeno enema with a turpentine corncob butt rub.  You analyze financial trends and give advice to investors??? Feel sorry for your clients!!!!!

"That said, if there were no increase, it would result in the US entering into a technical default and this would be followed by a downgrade to its rating by credit ratings agencies."

NO it WOULD NOT.  We have enough money and revenue coming in to pay for interest and that majority of our debts.  We WOULD have to select which debts to pay and not, but we do not "technically default", so not only are you a fucking ignorant analyst, you are also a LIAR!!!  You are a PRICK and need to self lobotomize, you fucking freak!!!!!

Sun, 07/24/2011 - 18:09 | Link to Comment Everybodys All ...
Everybodys All American's picture

What is bizarre to me is that no one mentions the utterly insane Federal Reserve that has been ruining the dollar and creating the environment for more deficit spending. Face it if the Fed had decided not to buy every friggin Treasury we would not be in this crazy mess. We might be in a recession but no one would be considering the dropping of AAA credit rating and the next likely hood of dropping the dollar as a reserve currency. Bernanke has to be mentioned along side the most idiotic people who have every run our government. For Obama to keep him at this point shows you his ignorance as well.

Sun, 07/24/2011 - 18:10 | Link to Comment Dollar Bill Hiccup
Dollar Bill Hiccup's picture

The Dollar Bill turned 150 last week so I'm too tired from the festivities to give a damn.

Or more prosaically, if the debt ceiling does not pass, let them eat cake.

Sun, 07/24/2011 - 18:24 | Link to Comment r101958
r101958's picture

This article points out quite well how warped the GDP measure is. When government spending determines the health of the economy. Let's face it. The real and accurate current GDP is whatever the GDP would be without the yearly deficit. Just remove the extra 1.5 trillion and then you will get a good idea of how we are and have been in a depression. The only reason it doesn't feel quite like it right now is because of all this deficit spending and of course the economy will not be fixed until that happens.

Sun, 07/24/2011 - 19:19 | Link to Comment Noah Vail
Noah Vail's picture

GDP is a complete fraud starting with the fact that it counts pretax dollars. The governmnt then taxes and spends the money so the tax is counted twice as "product". On top of that gvt borrows foreign dollars and counts that too as "product" when in fact all borrowing is a liability, not a fucking product.

By the logic of the GDP formula, the more the gvt borrows and spends, the better the economy is. All economists ought to be hung from traffic lights.

Sun, 07/24/2011 - 18:25 | Link to Comment Yes_Questions
Yes_Questions's picture

McConnell-Reid Plan. This is multiple stage plan which sees the debt ceiling increased by $100bn immediately followed by much larger increases in the future which are tied to matching spending cuts...

Uh, what?

Sun, 07/24/2011 - 18:36 | Link to Comment Franken_Stein
Franken_Stein's picture

 

The same Mitch McConell, whose Chinese-American wife Elaine Chao was once head of the department of Labor., when the Martin County sludge spill in Kentucky happened.

Guess who operated the sludge basin ?

 

Don Blankenship's Massey Energy.

 

http://en.wikipedia.org/wiki/Martin_County_sludge_spill

 

You Americans are ruled by scum.

And Blankenship is still NOT IN JAIL !

Even after 29 DEAD West Virginia miners !

 

For heaven's sake, put the asshole in the slammer !

 

Sun, 07/24/2011 - 22:16 | Link to Comment HungrySeagull
HungrySeagull's picture

There are hundreds of miners dead. I believe between Morgantown and Pittsburgh. A small memorial stands at the site next to the highway. I think they died between 416 and 500 feet down.

Sun, 07/24/2011 - 18:31 | Link to Comment snowball777
snowball777's picture

McConnell-Reid won't cut it if Timmay needs to issue 3X that $100B increase to "catch up", right? Their only politically viable plan is fiscally DoA. Buahahaha; fucking pikers.

Sun, 07/24/2011 - 18:33 | Link to Comment American Sucker
American Sucker's picture

I don't understand why the United States would necessarily enter technical default.  After all, debt rollovers could easily be met with current revenues.  Now, the United States would have to slash expenditures to revenue immdiately so as to not issue more debt, and that would cause serious pain, but that wouldn't be a default.

Sun, 07/24/2011 - 19:27 | Link to Comment Everyman
Everyman's picture

"Technical Default"
 is a lie just like the lies the congresscritters and the President uttered, that if the debt ceiling is not raised, the US will default.  BS, just for the reasons you post.

The "Rub" is that these politicians realize that some bills won't be paid, and are playing "hot potato" because nobody wants to pull the string on this and get the blame.  SOMETHING will get cut and has to get cut anyway, because we will be right back here again in 2-6 months.

Sun, 07/24/2011 - 18:45 | Link to Comment cfigueir
cfigueir's picture

 

pretty picture, except that real GDP was actually more like 1.75%, during QE2, and likely will come in lower for 2H 2011. Add in austerity (any plan will result in cuts and/or raises in revenue), and you have guaranteed drags. The probability of negative GDP this year, if not early next year, will be a near certainty with any austerity...

Sun, 07/24/2011 - 19:29 | Link to Comment Everyman
Everyman's picture

"The probability of negative GDP this year..."

 

Do you mean the probablity of OFFICAL NEGATIVE GDP this year?

Sun, 07/24/2011 - 19:01 | Link to Comment heywood jablowme
heywood jablowme's picture

Why is everyone ignoring Ron Paul...all the US needs is for Bernanke and Co. to forgive the interest and repayment of the debt the Fed is holding and the debt cieling is magically increased $1.7 trillion.  Tear up those bonds just like Goldman tore up its AIG CDS.  The fed can then just monetize more debt as its balance sheet will be reduced $1.7 tillion.

Sun, 07/24/2011 - 19:34 | Link to Comment goldsaver
goldsaver's picture

They cant. The 1.7T in debt are all in the balance sheet as reserves. It represents 17T in currency issuance. If the Federal Reserve has to contract the balance sheet by 1.7T, is has to pull the 17T out of existence. Add to that the CDS losses to banks and you have a whole lot of pain going on.

Sun, 07/24/2011 - 19:02 | Link to Comment heywood jablowme
heywood jablowme's picture

Why is everyone ignoring Ron Paul...all the US needs is for Bernanke and Co. to forgive the interest and repayment of the debt the Fed is holding and the debt cieling is magically increased $1.7 trillion.  Tear up those bonds just like Goldman tore up its AIG CDS.  The fed can then just monetize more debt as its balance sheet will be reduced $1.7 trillion.

 

Sun, 07/24/2011 - 19:15 | Link to Comment wombats
wombats's picture

What does a default, or even a slight delay in payments do to bank holdings, especially banks like BofA that are teetering on the brink of insolvency anyhow?  Do we start seeing at-risk banks start collapsing?

Sun, 07/24/2011 - 19:31 | Link to Comment Everyman
Everyman's picture

Hopefully we start seeing the criminals losing.  and YES I do hope BoA goes tits up.  They should have been reorganized years ago, and those that put this crap and lied about it ought to be in jail or drug behind a pickup until there is nothing left but boots.  These people are REALLY REALLY bad, and we need to get rid of them.

Sun, 07/24/2011 - 19:47 | Link to Comment bakken
bakken's picture

Wishful thinking.   The Treasury no llonger needs Congressinal approval for bail outs.  Credit Paulson for that one and Timmy needs no help to do what he woukd love to do anyway.  Evidently the toxic asset buy back from Fan/Fred hasn't been enough, the zombies are still entitiled to more and larger transfusions.

>>>>>>No Bank Blowouts while their punk is at the helm!!!!!

 

[OMG  Please do something about the size of this typeface!]

Sun, 07/24/2011 - 20:30 | Link to Comment cfigueir
cfigueir's picture

 

They will grow closer to insolvency as their leverage increases. As default risk gets priced into treasuries, the existing instruments held by banks being marked to market will drag down book values.

Mon, 07/25/2011 - 01:09 | Link to Comment Anonymouse
Anonymouse's picture

This may be a nit in the grand scheme of things, but the title of Figure 1 above has nothing to do with the chart.  How does the events of the last few months show up in any significance in a 33 year chart?  How does a plot of "Opinion about the government's economic policy" show that  "Fiscal drama weighing down on consumer confidence"?  Random charts don't really support an argument

Mon, 07/25/2011 - 03:04 | Link to Comment shahroodi
shahroodi's picture

in third scenario i will only buy gold and silver....neither treasury nor anything else worth to buy

Mon, 07/25/2011 - 15:48 | Link to Comment falga
falga's picture

Worse possible scenario would be to pass debt ceiling without doing anything.... This would simply kick the can down the road and possibly buy us no more than a few months and until more money is thrown into the economy at the cost of another increase of the debt ceiling

If by some miracle they agree to some sort of fiscal sanity then all is well for the USD and the economy but unfortunately least likely scenario...

Most likely scenario for the USD is to shut the government down because that does not require doing anything... This is what politicians do best!

Tue, 08/23/2011 - 23:27 | Link to Comment karmete
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Wed, 09/14/2011 - 02:20 | Link to Comment chinawholesaler
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Wed, 09/14/2011 - 02:22 | Link to Comment caerus
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