An impasse creates the risk of a disorderly default. Something can happen due to a very small event, like a sudden insolvency of a large European bank.
Of equal concern is the apparent failure of the U.S. deficit-reduction committee. Those who pooh-pooh this as a factor are forgetting that one of the catalysts for the large drop in equities in the end of July/beginning of August was the long delay on agreeing on an extension of the debt ceiling. That, coupled with the realization that contagion had spread to Italy and Spain, followed by the Standard and Poor's downgrade of U.S. debt, caused a nearly 2,000 point drop in the Dow Jones Industrial Average in about two weeks in August.
It was the S&P downgrade of U.S. debt — partially a consequence of the failure of the debt-extension committee — that was the final straw for the markets. The downgrade was announced after the markets closed on Friday, Aug. 5. That Monday, the VIX went from 32 to 48.
The failure of this committee — now the second deficit-reduction committee to fail since August — increases the likelihood of more U.S. sovereign debt downgrades.
1. We now have three new governments in Europe in as many weeks — Greece, Italy and now Spain. Before that, Ireland and Portugal threw out their ruling parties. The Socialists are out of Spain; the center-right Popular Party (PP) is in. Even though it was a rout — the PP took 186 seat in the 350-seat lower house — the party under Prime Minister-elect Mariano Rajoy has not clearly indicated what it was going to do, other than vague talk of reforming the labor market. He has a month before he becomes prime minister: expect a sweeping plan in a couple weeks.
2. Moody's has warned that France's deteriorating market climate might harm the country's credit rating: "Elevated borrowing costs persisting for an extended period would amplify the fiscal challenges the French government faces amid a deteriorating growth outlook, with negative credit implications," Moody's said.
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