Wall Street Expects Big Selloff If Debt Deal Isn't Reached

The stock market is likely to plunge if Congress fails to raise the debt ceiling by Aug. 2, but there is only limited upside if a deal gets done in time, according to the latest CNBC Fed Survey.


Nearly two-thirds of the 78 economists and Wall Street strategists and money managers who responded to the survey see a selloff of 3 percent or more if the debt ceiling is not raised. But a majority sees a debt deal as either neutral for stocks or spurring a rally of around 1 percent.

“Washington is populated by elected fools in both political parties,’’ wrote money manager David Kotok of Cumberland Advisors.

Tom Porcelli at RBC believes the Treasury can extend the deadline to Aug. 15. But if there is no deal by then, he said, “we would expect an extreme reaction and not necessarily just from a market perspective. The worst possible outcome from this would be recession, period.”

Meanwhile, the survey showed that despite some hints from Fed Chairman Ben Bernanke about the possibility of additional quantitative easing, Wall Street is unconvinced. Fully 68 percent of respondents believe there will not be additional QE in the next 12 months, about the same as CNBC found in May.

But the 19 percent minority who believe there will be QE, have increased the average size of purchases they believe the Fed will make. This group thinks that the Fed will purchase an additional $376 billion of assets in another QE round, up from $141 billion in the May survey.

“I only see additional QE in the event a European default causes a liquidity seizure,’’ wrote Constance Hunter of Aladdin Capital. “If by some miracle a Greek default can be orderly, then the Fed's powers to create liquidity may not be needed.”

Bernanke, meanwhile, gets a B grade from respondents, about what he got in December, the last time CNBC asked the question. A majority of respondents now say Fed policy is "just right" compared with a majority in May who said the Fed was too easy. Respondents have pushed ahead when they expect the first rate hike.

About 23 percent of respondents see the first hike coming in the third quarter of 2012, the number one response. Back in May 37 percent predicted the first quarter of 2012. Wall Street can’t seem to find a consensus on when the Fed will begin reducing the size of $2.6 trillion balance sheet.

The first quarter of 2012 was the top answer for when assets would begin, but it was chosen by only 15 percent of respondents. The second quarter and fourth quarters of 2012 tied for second place and 13 percent say 2014 or later, suggesting the market is confused about the outlook for this aspect of Fed policy.

By contrast, more than 30 percent see the Fed ending its language to remain easy for extended period in the first quarter of 2012 with another 22 percent saying it will happen by the second quarter of next year. Results were similar for when the Fed is expected to ends its reinvestment policy—28 percent put the date in the second quarter, and 15 percent say the second quarter.

Not surprisingly, respondents pushed down the outlook for the level of the Fed funds rate. By June of 2012, the Fed is seen setting its overnight lending rate at around 50 basis point; it’s currently pegged between 0 and 25 basis points. In May, the survey put the average at 70 basis points.

The Funds rate is seen rising to just more than 1 percent by the end of 2012, down from 1.4 percent in the May survey.

Stocks are seen rising another 3 percent through the end of the year and will be 7 percent higher a year from now with the S&P rising to 1420 from the current level around 1332. But Wall Street has shaved its forecast for GDP by about a third of a point to 2.7 percent for this year. It's seen rising only modestly next year to 2.8 percent. The 10-year is seen a half point higher by year-end and rises to 3.75 percent a year from now.