Investors sound more nervous about the looming deadline to raise the debt ceiling, but the stock market’s not freaking out. That market calm is the result of a catch-22, says Frederick Cannon, global director of research and chief equity strategist for Keefe, Bruyette & Woods. I talked with Cannon to understand the conflicting signals and what to watch.
Cannon says investors believe that Congress will fix the problem and raise the debt ceiling if there’s a market crash—which, in turn, would increase stock prices. For people holding long positions, that outlook gives little incentive to get out of the market if it’s going to go back up. For investors considering shorting the market in a bet that it will fall, there’s little incentive to get into the market because they also think it will rise.
That dynamic has created an incentive to “sit on their hands,” Cannon says, and do nothing. Yesterday, for example, even as the debt-ceiling D-day inches closer, trading activity in the Dow was more than 7 percent lower than the 30-day average and down more than 21 percent compared with the prior 100 days. And while the VIX, an index that monitors volatility, has risen since the shutdown began, it’s still below its historic average, let alone levels seen in other crisis moments. The usual signs of stress, Cannon says, aren’t registering.
We are already seeing some tremors in trading of one-month Treasuries as Fidelity and others sell off their holdings of short-term government debt. But that doesn’t yet signal a marketwide panic. “When is the crisis just a bunch of Wall Street types trading things,” Cannon asks, “and when can it affect the real economy?”
That rubber-meets-the-road moment may come if the $3 trillion repo market tightens up, limiting the ability of some kinds of companies to borrow overnight to manage their liquidity. That arena saw some uncertainty during the debt-ceiling showdown in 2011. “If you did start to see things freeze up in the repo market or short-term Treasury market, people in the equities market would start to sell off,” Cannon says. Until then, investors are stuck in their catch-22—and they’re not alone. “The hard part,” he adds, “is the situation is giving free rein to Congress to not do anything.”