As Washington fiddles with debt, Wall Street yawns

As Congress and the White House drive the country’s budget and debt rating closer to the edge of a cliff, global financial markets have greeted the impending calamity with a collective yawn.

Something doesn’t quite add up here. Either fears of an economic Armageddon are vastly overblown, or investors are setting themselves up for a nasty surprise.

For now, Wall Street seems convinced that Washington won’t drive the country into a financial abyss.

“We're having a massive circus,” said Robert Doll, chief investment officer at BlackRock Advisors. “It's not going to be fun. In the 12th, maybe 13th hour, we'll get something done. And we move on."

Washington and Wall Street have played this game of chicken before. Following the financial collapse of 2008, Congress balked at approving a $700 billion bank bailout package. The Dow Jones industrial average tumbled hundreds of points, including its biggest one-day point drop ever.

Ultimately Congress approved the measure and the markets recovered. Wall Street's takeaway: In the end, Congress won't risk the ire of financial markets.

In an earlier budget standoff, President Bill Clinton's advisor James Carville summed up Wall Street’s assessment of the balance of power: "I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody."

For the moment, investors seem to believe that the bond market will again assert its influence and force a compromise that heads off another financial panic. Late Friday, when the latest round of budget talks collapsed, both sides hinted darkly of the possible repercussions Monday in the financial markets.

But traders took the news in stride. The stock and bond markets largely shrugged off the ongoing budget chaos in Washington Monday. Stocks sold off modestly at the opening but then recovered. Gold, typically a safe-haven investment, traded slightly higher.

"A lot of people down on the floor are meeting this news with a collective yawn," said Tres Knippa, a futures trader at Lotus Brokerage in Chicago. "These are politicians playing politician games. Everybody knows that some compromise will be reached and we'll move on from here."

Once they look past the budget chaos on Washington, investors have more upbeat news to consider. Despite signs of slowing in the U.S. economy, the latest round of earnings reports have been coming in stronger than expected.

"(It's been) fantastic week for corporate earnings," said Doll. "Seventy-five percent are reporting better than expected revenue growth. So far for the companies (which have) reported it's up high single-digits vs. a year ago. That's not so bad."

That's especially true for the largest U.S. companies. They are generating strong profits from a global economy that's growing much more rapidly than the anemic U.S. recovery.

On Friday, Credit Suisse economists said they see global GDP growth picking up in the second half to about a 4.4 percent pace — more than double the current rate of U.S. growth. Roughly 80 percent of that growth is coming from outside the developed world, according to Mike Thompson, a market analyst at Standard & Poor's.

"You can have good profitability for an S&P 500 company, even if you have a relatively anemic U.S. economy, because they're very skilled at optimizing how they run their business," he said. "A lot more of the profits are going to come from the tail winds of international businesses."

To be sure, not everyone is so sanguine about the possibility of the federal government hitting the budget wall Aug. 2 and defaulting on the national debt. Even if a compromise is reached, some analysts are worried that it will be too little, too late to satisfy global investors that U.S. Treasuries are still a virtualy risk-free place to park their money.

"It's reasonable to assume they will reach some sort of compromise to avoid a default; the question will be what is in that compromise," said David Woo, who follows interest rates and currencies at Bank of America Merrill Lynch Global Research. "If the market views this as insufficient and kicking the can down the road, that's when you'll see the real disorderly conditions that we haven't seen so far."

Wall Street analysts have also been taking a closer look at technical scenarios that might play out if Congress and the White House can't reach a compromise before the deadline. Some have speculated that the White House could invoke extraordinary legal powers to continue writing checks.

Meanwhile, armies of budget analysts have been tracking the money flowing in and out of the Treasury to try to determine just how much cash Uncle Sam has left to pay the bills. Though the $14.3 trillion debt ceiling was officially reached in May, the Treasury has been juggling furiously to postpone the day when the expenses exceed the cash available. Based on accounting moves available then, the Treasury estimated it would run out of money Aug. 2.

But cash inflows to the government can be tough to predict precisely that far in advance. Economists at Barclays Capital say they’ve been watching the numbers closely, and there seems to be more money coming in than originally projected.

"This suggests that the date on which the Treasury will run out of cash to pay its obligations might not be Aug. 2; it might be around Aug. 10 instead,” the firm wrote in a note to clients last week.

While a week might buy Congress and the White a little more time, there’s no indication that it would have much impact on a political impasse that appears to be cast in cement. Nonetheless, many on Wall Street seem convinced that a solution will be reached that spares the global markets a repeat of the Panic of 2008.

“We are heading in an austerity direction,” said Doll. “We're debating how much and what programs. We'll get there. None of us like the way were getting there, but we'll get there.”