As I write this, Congress and President Obama are engaged in a high-stakes game of chicken on the debt limit. Congressional Republicans (mostly Tea Partiers) refuse to increase the nation's credit limit without major spending cuts. Further, they've rejected any tax increases as a way toward fiscal sanity.
The media is in an absolute tizzy over the possibility of default. Will interest rates skyrocket? Will our economy grind to a halt? Will social security checks and Medicare reimbursements be scuttled? And what about the Armed Services? Will our brave fighting men get paid?
Interestingly, the markets have largely yawned over the whole thing. US Government bonds (after a week-long plunge on the heels of QE2 expiration at the end of June) have rallied back to where they were in mid-June. The stock market has done it's usual midsummer random walk/drunken stagger. In short, the markets think that a deal will be reached (after each side makes a big show of storming out of meetings, a few Tea Party nuts threaten to let the country default, and the Congressional Cots are dusted off for an all-nighter).
But, what if the markets are wrong? I know, I know, the markets are always right. But what if the Tea Partiers really are crazy enough to let the country default? What if the Dennis Kucinich Democrats decide to go to the wall over entitlement cuts? What if we really get close to Tim Geitner's Aug. 2 drop-dead date without a deal?
As this possibility dawns on Wall Street, expect yields to rise on all fixed income (corporates will follow Treasuries). Slowly at first, then more vigorously. The stock market will follow suit. It could get really ugly.
Then, after the Dow is down about a thousand points or so, and TLT down 10, The Washington Wankers will finally get it! It's time to get a deal done. Because if they don't, nobody's getting re-elected.
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