Friday, July 15, 2011

Breaching the Glass Debt Ceiling

As I predicted 2 months ago, cooler heads would ultimately prevail and the debt ceiling will be raised before the deadline is reached. We are, at last, seeing indications that a debt ceiling compromise is in the works.

We are not out of the woods yet. As I predicted, the debt ceiling showdown has played out like a hardcore suspense movie that keeps people at the edge of their seats, and that the suspense will make many people in high places very nervous. In the weeks following the start of the showdown, the US Chamber of Commerce and the banks have been furiously lobbying to get the debt ceiling raised.

We have seen more signs of people in high places getting nervous. First, Timothy Geithner has been warning that we are running out of time on the debt. Second, credit rating agencies have been hinting that they may downgrade the rating on US credit, even in the event of a debt ceiling deal. Third, President Obama warned that there is no guarantee that Social Security checks will be delivered if a debt default occurs.

We are already seeing clear indications that the game of chicken is going to end before the month comes to a close, as Sen. Mitch McConnell has shown signs of willingness to make concessions.

Social mood will likely determine when a debt ceiling compromise will get hammered out. Although the next leg down in social mood has already commenced, the trend is still in its infancy. Although the political arena is polarized, there is still a reluctant willingness to compromise as there is still a lot of optimism.

Here is a short term chart of the DJIA, which is the "mood meter" of the United States population.

Even as hints of a coming debt ceiling deal are now emerging, there is still a lot of tension in the political arena. Expect the political drama to last for another week or so with Rep. John Boehner and Rep. Eric Cantor continuing to treat the debt ceiling as a political football. Afterwards, we will see one last blow-off rally. It is very likely that the debt ceiling will be raised sometime between July 25 and July 29. It's hard to say whether we will get a clean debt ceiling bill signed into law. The most likely scenario is that both the GOP and the Democrats will end up making significant concessions to get the debt ceiling raised, which is consistent with a reluctant willingness to compromise.

The ironic thing is that after the debt ceiling gets raised, the DJIA is expected to take a hard plunge and the next leg up in the US Dollar Index is expected to commence. Here is the intermediate term chart of the DJIA.

On the longer term, the United States will not default on its debt this year. There is no doubt that nervousness over the debt ceiling will continue to build on the short term as we get closer to the deadline. A debt default will eventually occur, but it will be due to rising interest rates making the existing debt burden too heavy to bear. We are looking at 2013 or 2014 as when the United States will default on its debt.

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