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Leaders Playing Dangerous Game with Nation's Debt Rating

Leaders from both parties in Washington are playing a dangerous political game with the nation's AAA credit rating. The first self-imposed deadline of July 22 to have a framework of a debt-ceiling deal in place has already passed. The second and firmer deadline of August 2 is a little more than a week away. Despite Standard and Poor's warnings of a possible debt downgrade if realistic deficit-reduction plans are not agreed upon, the Wall Street Journal included the following in their update from Sunday night:

Congressional leaders from both parties were developing competing deficit-reduction plans, but they released only broad outlines and few details. Several aides stressed the plans were still evolving.

'Broad outlines', 'competing', 'few details', and 'evolving' are not terms that build confidence in the minds of market participants. Although volatility has picked up, the financial markets have thus far remained relatively calm in the face of ever-increasing uncertainty about the outcome over the next eight days. The term default speaks to missing scheduled payments to holders of U.S. Treasury bonds. Like many markets during these uncertain times, the market for U.S. debt has been giving some mixed signals.

The long-term Treasury exchange traded fund (ETF) is shown below; it trades under the symbol TLT. Market sentiment can change quickly, especially when credit ratings are involved, but at the end of last week the Treasury market was not foreshadowing impending earth-shattering doom. The intermediate-term trend for Treasuries remains up (yes, up), as indicated by the series of higher lows (see green arrows). However, the longer-term outlook is showing some cracks. The negative slope of the 200-day moving average (orange and red arrows) is a yellow flag for the price of bonds. The importance of the 200-day, in all markets, is covered in this video. The price of bonds recently made a higher high (see A and B), but the Relative Strength Index (RSI) made a lower high (A1 and B1), which indicates waning short-term interest from buyers of U.S. debt.

iShares T-Bond 20+y

The last noteworthy item in the chart of Treasury bonds above is the increasing volume on "up days". These positive spikes in volume tell us market participants believe some form of a debt deal will get done before August 2. Obviously, that belief is subject to change over the next eight days. Our concern is that the tone in the bond market may abruptly shift in a negative manner if the bickering and political posturing in our nation's capital does not subside soon (very soon). Our leaders may not fully respect that once the market for U.S. Treasuries makes a sharp bearish turn, it may be difficult to repair the damage.

How does all this help us? The state of the bond market heading into this week questions the validity of the calls for the end of the world as we know it. The markets are in relatively good shape given the problems of the day. Markets that can digest bad news tend to be markets that surprise on the upside. Until the evidence begins to shift (and it may), we will continue to give the bull market in U.S. stocks (SPY) the benefit of the doubt, while holding some gold (GLD) and silver (SLV) as insurance against poor leadership from our elected officials. We will pay close attention to all markets in the next eight days with an open mind.

 

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