Debt ceiling vote – the aftermath

August 4, 2011

On Tuesday, August 2, the United States Congress (House and Senate) voted to increase the debt ceiling for the U.S. government to $16.7 trillion from $14.3 trillion. The increase means that the U.S. Treasury can continue to pay the government’s bills (health care, military, civil service, etc), and avoid default. One condition of this vote was the creation of a bi-partisan body to decide what cuts are to be made to the U.S. budget. These cuts must total $1.2 trillion, and decisions must be made by November 2011. If this does not happen, it will trigger a $1.5 trillion automatic spending cut across the board – half from domestic spending, and half from defense spending.

How markets have responded

U.S. equity markets dropped, both during the political turmoil surrounding the vote, and on recent reports that the U.S. economic growth rate may be slipping. U.S. bond markets (U.S. Treasuries) went up in value (yield lower) however, indicating that fixed-income investors still consider the United States a “safe haven”.

Why did equity markets not respond more positively to the debt “resolution”?

The real issue that was debated in the United States was not the debt ceiling, but rather the United States budget deficit, currently estimated by the International Monetary Fund to be 10.8% of GDP in 2011. The concessions resulting from the debt ceiling resolution do little to address the real structural issues with the United States government budget and debt. This has investors concerned about the management of the ongoing economic situation.

MD’s view

One of the many economic factors that MD follows is the continued ability of global policy-makers to “get it right”. This ability was brought into question during the recent U.S. political turmoil. It is also important to note that several reports, published last week, indicate a weakening in U.S. economic growth (manufacturing index, job reports, GDP growth rate revision).

We believe that the United States economy will continue to grow, although perhaps at a slower pace than expected, with fiscal tightening now on the horizon. We expect global trade will continue to expand, and policy-makers to continue to make sound decisions and create more certainty for global investors. We encourage investors to maintain a well-structured portfolio, adhere to long-term strategies and work closely with their financial advisor.

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