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Odds Spike to 40% Chance that DC Crashes Debt Deadline

On Monday investors were trying to figure out which end was up after late developments in Congress again led to speculation that lawmakers would put partisan politics ahead of a debt deal.

In a live interview on CNBC’s Halftime Report FBR policy analyst Ed Mills says that according to his proprietary research, there’s a growing probability that Washington leaves Wall Street hanging.

”We see a 40% chance that we get to Tuesday and no deal is done,” he says. “That’s pretty high.”

In the event lawmakers crash the deadline, “the US Treasury takes the lead in deciding who gets paid what -- and in what order if we hit the debt limit,” explains CNBC's Jane Wells.

Of course almost every pro and pundit agree that sooner or later lawmakers will achieve some kind of resolution even if its only a Band-Aid.

It’s really what happens next that could be more damaging for investors.

That’s because if and when a debt deal happens – the cuts included in the legislation may not be enough to prevent S&P from downgrading the credit rating of our nation. “That’s the wildcard,” says Mills.

”I fully expect to see the S&P downgrade the US credit rating within the next 60 days,” adds Fast trader Joe Terranova.

As things stand at the time of writing, lawmakers must agree on $4 trillion in reductions over 10 years to avoid the downgrade. And with so much dissent in Washington, Terranova doesn’t think that kind of cooperation is even a remote possibility.

Although the economic ripple from a downgrade can't be quantified completely, according to published analysis it would add $100 billion a year to the cost of servicing the nation’s debt and it would increase interest rates on mortgages, car loans, student loans and more.

The ultimate X-factor is that in an already weak economy even marginally higher costs to borrow money could send the economy back into recession.

If you’re looking for a play, most Street pros expect a relief rally when there’s some kind of resolution but Mills tells us, “the overhang from the credit rating agencies is really going to weigh on stocks.”

Mills and trader Patty Edwards are among a growing chorus of market pros who suggest moving to the sidelines “until the air clears.” Earlier in the week both Dennis Gartman and analyst Dick Bove recommended similar strategies.

* You can find our conversation with Mills about 9 minutes into this video clip.

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