It's begun. The first negotiating session between Congressional leaders and the White House over the looming austerity crisis started Friday morning, as the two sides seek a way to prevent the “fiscal cliff” of tax hikes and spending cuts that would take effect Jan. 1 absent a deal.
It seems hard to believe that the presidential election was only 10 days ago. Since then, as people have turned their attention to fiscal policy, it has seemed that every day’s headlines out of the financial markets are attributed to the latest chatter from Washington. But what is Wall Street really telling us about the fiscal cliff? After only six trading days in which the looming austerity measures have been at the front of investors’ minds, the message is: What, me worry?
Markets can be wrong about the future, of course (ask anyone who bought bank stocks in 2007). As I wrote earlier in the week, there is reason to fear even a short bout of the austerity crisis. But markets do represent the collective judgment about where things are heading from people willing to put vast sums of money where their mouths are, and so their lessons are worth considering. Here’s what they’re saying. (All numbers are Thursday closing prices.)
Recession? Nah. There isn’t much evidence that investors are pricing in a recession or even a meaningful downturn as a result of the austerity crisis. Rather, they are betting it will get resolved without a major downward pull on the economy. When investors fear an economic downturn, they tend to move money away from stocks and other risky assets and into bonds. The yield on U.S. Treasury bonds is down since Election Day (the government could borrow money for two years at 0.30 percent on Nov. 6, which is down to 0.24 percent). And the Standard & Poor’s 500 has fallen on four of six trading days since the election for a total decline of 5.3 percent. But those aren’t recessionary moves, just fairly routine bumps in the road. Both measures of the outlook remain within their usual range over the last few months. Both bond yields and stock prices were lower as recently as July.
It will be solved without causing wild gyrations. Investors also seem confident that the standoff can be resolved without the kind of dramatic ups and downs during the intense phases of the European debt crisis and the global financial crisis of 2008. The Vix index of expected future stock market volatility stands at 18, meaning that markets expect the stock market’s swings over the coming month to be equivalent to an 18 percent move over a full year. That’s the same level it was at in July 2007, before even the first ripples of the global financial crisis. It is far, far below the peak of over 80 in November 2008, over 45 in May 2010, and almost 50 in August 2011. Essentially, markets are assuming that a deal can be reached without teeth-rattling market swings that put pressure on lawmakers. The Vix is also well below its levels from as recently as last summer.
Austerity isn’t urgent. There are widespread calls from business leaders to use these negotiations to set in place a longer-term strategy for bringing down the nation’s large budget deficits. That may be desirable, but there is almost zero pressure to do so coming from the bond markets. If anything, global investors are flinging money at the U.S. government, essentially letting the Treasury hold their money for free. The yield being paid on “Treasury Inflation Protected Securities,” bonds which adjust for inflation, is actually negative for all but the longest-term bonds. A 20-year, inflation-protected Treasury bond yields -0.105 percent, for example. Translation: I, global investor, will happily give you $10,000 now, in return for your promise to return to me money worth $9,989.50 in today’s dollars two decades from now. That is a global marketplace shrugging at any need for the U.S. government to tighten its purse strings.
We trust America. The low Treasury borrowing costs are just one show of a sense among global investors that, whatever drama may be attached to negotiations over U.S. fiscal policy, ours is basically a sound economy that will be managed well. That also shows up in the value of the dollar against international currencies, which has been rising recently. The dollar index, measuring its value against six other major currencies, is basically unchanged since the election and up 2.8 percent since Oct. 17. Over a longer term, the value of the dollar has been bouncing around in a fairly narrow range for the last year and is up significantly since the spring of 2011. The United States may have problems, but global investors look around the world and think ours are not so bad. We can all hope that political leaders prove them right.