With a debt limit deadline less than 14 hours away, the Dow Jones industrial average was up more than 180 points, or 1.2%, in early trading. The S&P 500 was up 1.1% and the Nasdaq composite was 1% higher and trading at a fresh 13-year high.
Investors are betting a deal gets done.
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The reason: the fallout of a U.S. default would be so unpredictable and potentially damaging to the financial system that few people on Wall Street think Congress would let such a self-inflicted wound occur.
"We have to assume that it is in no one's interest for the government to default," says Rob McIver, co-portfolio manager at Jensen Quality Growth Fund.
The short-end of the U.S. bond market, however, continues, to shows signs of distress. The yield on the Treasury bill that comes due on Oct. 31, dubbed "The Halloween Bill," has seen its yield jump to 0.60% in trading today, despite trading in a normal range of 0.05% to 0.10% for most of the year before moving higher and higher this month, according to a Bloomberg chart supplied by UBS.
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This type of short-term bond is typically referred to as a risk-free asset, but investors are selling these bills because they are the most likely government security to be hit by a U.S. default, according to Boris Rjavinski, an interest rate strategist at UBS.
Global markets are in waiting and watching mode.
In overseas trading, the Nikkei 225 Stock Index closed up 0.18% to 14,467.14, however Hong Kong's Hang Seng fell 0.46% to 23,228.33.
Similarly, key European stock indexes were trending lower, with Britain's FTSE 100 index down slight! ly 0.40% to 6,522.37. Germany's DAX 30 index was down 0.10% to 8749.72, while France's CAC 40 index was down 0.70% to 4,224.39.
Still, in the U.S., investors are nervous. And financial markets are in limbo as they wait to see if Congressional Democrats and Republicans can strike a budget deal in time to avoid a debt crisis that could cause the U.S. to default on its debts for the first time.
The clock is ticking closer to the key Oct. 17 deadline -- that's tomorrow -- that will either return sanity to Wall Street or cause potential chaos. When the deadline comes the U.S. won't be able to borrow any more unless lawmakers act to extend the debt ceiling. Barring an agreement, the U.S. won't be able to pay all its bills.
The biggest risk is if sometime after Oct. 17, the U.S. misses interest or principal payments on government debt it has already issued. Such a default could undermine the world's confidence in a financial asset that's long been viewed as the safest investment on Earth.
Due to political brinkmanship, after last night's market close Fitch Ratings cited the potential hit to confidence due to a potential default as a reason it placed the USA's AAA rating on "rating watch negative."
Standard & Poor's, of course, downgraded U.S.debt to AA+ in the summer of 2011 after the last debt-ceiling fight. And John Chambers, chairman of S&P's sovereign debt committee told "CBS This Morning" today that if the U.S. does not pay its bondholders on time and defaults, the reaction in financial markets would "probably be an event that would be much worse than (the bankruptcy) of Lehman Brothers" back in the fall of 2008.
Still a Q&A research note put out yesterday by credit rating agency Moody's Investors Services that downplayed the odds of a credit rating downgrade for the U.S. has provided a sense of balance to the ratings downgrade debate.
Memories of the bad market reaction to the last debt-ceiling fight in Congress back in 2011 has some investors worrie! d. As the! talks dragged on in July of 2011 before ending in a last-minute deal to avoid default, the Dow suffered an eight-day losing streak in late July and early August. The blue-chip gauge then plunged 635 points, or 5.6%, on Aug. 8, 2011, the first day of trading after the S&P credit downgrade.
"The problem with the U.S. not paying investors on time is that it can destroy the very special status of Treasuries as a super-safe, liquid investment," says Rjavinski. "Treasuries are like an invisible glue that binds all of the world's financial markets. We can have a pretty bad chain reaction if there's a default."
The stock market has navigated Washington gridlock nicely so far. Despite a 133-point drop for the Dow Jones industrials on Tuesday after Congress failed to sign a deal, the Dow was still up 0.25% during the 15-day government shutdown. If the deadline passes without a deal, however, stocks would likely suffer a "strong negative reaction," says McIver. If a deal gets done, the market will refocus its attention on corporate earnings and economic growth, he adds.
But there have been more concrete signs of worry in the U.S. government bond market, especially one-month Treasury bills that will come due between Oct. 17 and early November, when the nation is expected to run short of cash.
Many banks and big investors have been selling these short-term instruments that could be hit by a potential default, says Bill Hornbarger, chief investment strategist at Moneta Group.
"Everyone is selling stuff that matures in October," he says.
A Treasury bill that matures on Oct. 24, seven days after the nation's ability to borrow ends, has seen its yield jump from roughly 0% in mid-September to more than 0.40% in recent days, according to a Bloomberg chart supplied by Rjavinski.
Similarly, a government auction of 3-month bills Tuesday also saw yields rise as high as 0.13%, vs. a high of 0.035% at last week's auction.
The issue isn't that investors don't think they wi! ll get pa! id back eventually, says Rjavinski; it is that they won't get paid on time.
"It's telling us investors are getting nervous," says Rjavinski.
Intel was down 0.99% to 23.18 in premarket trading despite topping Wall Street's estimates Tuesday by reporting a 49% increase in quarterly profit of $3 billion, or 58 cents a share.
Mike Snider contributed.
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