The debt feud will likely continue to take its toll on markets Thursday, as the deadline to raise the debt ceiling closes in and lawmakers are still far apart.
Stock market selling Wednesday became more aggressive, as traders and investors became increasingly convinced Congress will be unable to develop a strong enough fiscal plan to stave off a downgrade of the U.S. AAA credit rating.
"This sideshow we're seeing all day long from Washington is too much for a fragile economy. They've got to get their act together," said one trader, reflecting the view of many. "Confidence has to come from the top. It's disgraceful. Until it gets cleared up, you're going to see more of this. We're prisoners to the headlines."
The Dow Wednesday lost 198 points, or 1.6 percent to 12,302, its steepest loss since June 1. It is now down 3.3 percent over a four-day period. The S&P 500 fell 27 points or 2 percent to 1,304, below its 50-day moving average of 1,310. The Nasdaq skidded 2.7 percent to 2,764.
Treasurys fell as well, with the yield on the 10-year rising to 2.9810 percent. The dollar was mixed, rebounding in New York trading after early losses. It was up almost a percent against the euro, which fell as investors reacted to widening spreads on Italian and Spanish debt and another downgrade of Greece.
"I think the markets are sort of walking on egg shells again," said David Gilmore of FX Analytics. He expects the dollar to continue to lose to such currencies as the Canadian dollar, Australian dollar and Swiss franc.
"We have the competing horror shows on fiscal policy in the U.S. and Europe and it's a bit of a standoff for euro/dollar," he said.
Traders have been discussing the various scenarios of what might happen in Congress, and they are increasingly convinced the outcome will be a vote to raise the debt ceiling at the eleventh hour, accompanied by a weak plan to reign in the deficit that could result in a single notch downgrade of the U.S. credit rating. That would likely result in an immediate move higher in interest rates.
"One thing I would say is the bond market is pretty rock solid. It hasn't flinched in this whole Washington debt debate. That just tells me it's bullet proof. It's not going to quake," said Gilmore. "... we're going to have our days and our sessions where people do have a go at stocks, and have a go at U.S. banks and financials and have a go at the dollar — even have a go at Treasurys. But there's no sign of any where near as big a problem for us as what we've seen out of Europe in the last six months, and particularly the last eight weeks. Nothing close. My guess is we're not going to get a huge massive loss of confidence in U.S. Treasurys."
Brian Edmonds, head of Treasury trading at Cantor Fitzgerald, said he thinks the message from the bond market is that it expects a deal in Congress before the Aug. 2 deadline. "Any deal that gets done is going to be negative for the economy and bond friendly. It's a very confusing time to say the least," he said.
"It's hard not to look at what's going on on Capitol Hill and in our political system and not be discouraged. Between last week and today, we've made negative progress... To me the bond market is not panicking. The rates are not rates where people are panicked about the creditworthiness of the United States. It makes you want to scratch your head. It is a trade where you probably could see a quick spike to higher yields around a downgrade. I think that's coming," Edmonds said.
"Maybe we see the spike in rates and then the flight-to-quality, but the flight would be to the thing that causes the flight-to-quality... We're in completely unchartered territory, he said.
Treasury Wednesday auctioned $35 billion in 5-year notes, an auction that disappointed. "The 5-year was pretty lightly subscribed. It was a pretty poorly received auction, but it's held up pretty well," Edmonds said.
But Treasury also sold $12 billion in five-day cash management bills at an unusual zero-interest, a sign of market anxiety spilling into the short-term funding market ahead of the Aug. 2 deadline. Treasury reiterated Wednesday that it would lose borrowing authority at midnight Tuesday, unless Congress raises the debt ceiling and that is now viewed as the last safe day by some investors.
"It came in at zero," said Edmonds. "There's a lot of single digit bills. To have any auction that stops at zero is unusual...It's a scarcity of bills, scarcity of collateral."
What to Watch
Weekly jobless claims are expected to remain about the same as last week, at 418,000, when they are reported at 8:30 a.m. ET. May pending home sales are reported at 10 a.m. At 1 p.m., there is a $29 billion 7-year note auction.
There are also dozens of major earnings reports, led by big oil. Exxon Mobil and RoyalDutch Shell both report ahead of the opening bell.
"Despite the nagging day to day issues, the market has been pretty resilient in the face of it, and I think it just gets back to the corporate earnings were pretty good," said Andrew Burkly, market strategist at Brown Brothers Harriman.
He said, however, he does not believe forward earnings forecasts reflect what is going in the economy and he does not expect stocks to advance above their recent range until estimates come down.
"We don't think we're at a major inflection point," he said, adding it's possible stocks get to a level of 1,230 on the S&P 500. He is watching the 1,250 level as the next important area of support, and if there is a downgrade of the U.S. credit rating, the market could go to that level.
"If we're close to 1,250 on the downside, I would argue the market's priced it in," he said.
Burkly said he expects Congress to raise the debt ceiling but it's also likely the credit rating is cut. "The overall economy and economic recovery is still a challenge because the very last thing you want to be doing is cutting spending when growth is slowing," he said.
Other companies reporting earnings include AstraZeneca, Credit Suisse, DuPont, Sanofi, Bristol-Myers, Colgate-Palmolive, CME Group, International Paper, Kellogg, Raytheon, Thomson Reuters, Sony, Barrick Gold, Boston Scientific, Potash and Starwood.
Chesapeake Energy, Coinstar, KLA-Tencor, Starbucks, Expedia, Genworth and MetLife report after the closing bell.
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