The Next Debt Ceiling Disaster

A trend is emerging: A host of MSM pundits/analysts/economists are predicting a complete catastrophe right when the debt ceiling comes up.

To wit:

• At Bloomberg View, economist partners Betsey Stevenson and Justin Wolfers predict that the next debt ceiling fight could sink the entire economy, in part thanks to the fiscal cliff issues being felt at the same time. They point to the economic deterioration seen last summer (when confidence collapsed around the time of the debt ceiling fight) as evidence for the trouble.
• Ezra Klein recently called the next debt ceiling fight as something approaching a Lehman moment, again because it could come amidst the fiscal cliff miss.
• At Slate, Matt Yglesias has argued that because Republicans have already reneged on the last debt ceiling deal, that making another deal will be even harder.

Meanwhile, Citi's credit strategist Jason Shoup recently came out with a note saying markets were way too complacent about the coming storm:

As such, we believe that it's far more likely than many anticipate that the US economy actually does fall off the fiscal cliff. To be fair, our base case is still that the politicians end up temporarily extending many of the tax expirations. But there's a significant chance even this is not achieved, especially in light of the Speaker of the House's insistence on once again tying the raising of the debt ceiling (which will need to be done in early 2013) to spending cuts.  

Moreover, there's a high likelihood that the spending cuts due to sequestration are enacted. A modification to the defense cuts is desired by the Republicans (which may or may not be politically feasible), but neither party has expressed much interest in rolling back the cuts. That's a drag of 0.6% to GDP alone, although Citi’s economic forecasts already assume fiscal tightening of about 1% of GDP in 2013.

From the market’s perspective, asset prices do not correctly reflect the risk of another policy failure like the one that occurred last year, in our opinion. In the months prior to the most recent European sell-off we were hard pressed to find more than a handful of investors that were truly worried about the prospect of a self- inflicted recession in 2013, or the damage that could be done to confidence
beforehand even if a deal was ultimately reached at the eleventh hour. While aware of the issue, most thought it would be contained to the fourth quarter and more or less a non-issue.  

The question to our minds is: Are markets still that complacent? We’d have hoped that recent comments by the Fed and the Boehner-Reid back and fourth would have raised a few eyebrows at the very least. But with valuations more reflective of European risk, it’s difficult to determine what’s truly priced in.

Bottom line: People are growing more grim, and the thinking is that it's not priced in.

We should also note something else: The US market basically held up until after the debt ceiling fight was over last year. It was only in the aftermath that we really got the hard plunge. This time it's all being telegraphed and worried about much earlier.

Read more: http://www.businessinsider.com/the-next-debt-ceiling-disaster-2012-5#ixzz1wP2lsrfc