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Week Ahead: Debt Votes Dominate but the Economy's Story Will Matter

The outcome and consequences of Washington's deficit reduction efforts are as yet unknown, but what is clear is the heavy calendar of economic reports in the week ahead will have consequences of its own.

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AP

The economic data will give a first glimpse at the state of the economy in the third quarter, after Friday's soft GDP numbersshowed the economy grew at a much slower-than-expected pace in the first half of the year. The most important report is Friday's July employment report, but there is also ISM manufacturing data, monthly auto sales and updates from chain stores on their monthly sales.

Stocks declined this past week, making for the first negative July in three years. The S&P 500was down 3.9 percent to 1292 for the week, and 2.2 percent for the month. The Dow lost 4.2 percent for the week and was down 2.2 percent for the month. Nasdaq fell just 0.6 percent to 2756 for the month, and lost 3.6 percent on the week.

The market became increasingly anxious with each passing day, as Congress bickered and postponed voting until Friday. Congress was expected to stay in session over the weekend in an effort to reach an acceptable plan by Monday. The first vote in a series finally came Friday evening, when the House approved a plan put forth by Speaker John Boehner, which was then promptly rejected by the Senate. Still, the back-to-back votes were seen as progress toward reaching a bipartisan compromise. The legislation must be agreed in time for Congress to approve an increase in the debt ceilingbefore Tuesday's deadline.

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"You've already seen a very bad week in the stock market. It's going to get worse unless they do something," said Larry Kantor, head of research at Barclays. "These plans — the Boehner plan, the Reid plan — they are incredibly similar. They don't cut anything. The important thing is to set out a plan. You can backload and defer it because the economy is weak."

As investors sold stocks in the past week, they still sought the relative security of Treasury bonds. Their buying drove yields lower, with the yield on the 10-year slipping to 2.804 percent. T-bills however, saw a jump in yields as investors moved money to cash.

Economists have been warning that the sparring in Washington and the uncertainty it brings could impact the already low level of growth in the economy. J.P. Morgan chief economist Bruce Kasman, in a note, said while the idea of a grand bargain that would cut entitlements and deliver tax reform is fading, he expects the competing proposals from Boehner and Sen. Harry Reid would lower the baseline primary deficit by less than 0.5 percent of GDP through 2016.

"Although the opportunity for constructive change may be slipping away, the risks that the debt ceiling crisis does lasting damage remain high. We continue to believe that the Treasury will not default on its debt obligations but lingering concerns are driving large institutional investors to shift money away from Treasury bills to bank deposits," he wrote.

Many analysts and trades have come to believe the odds are rising that the deficit reduction legislation will not be sufficient to head off a ratings downgrade of the United States triple-A credit rating by Standard and Poor's. Moody's, however, said it's likely to leave the U.S. rating at AAA for now, despite the "limited magnitude" of the plans being voted on. But the U.S. could receive a negative outlook, meaning it could face future downgrade depending on the economy's performance in 2012 and further deficit reduction steps.

The debt drama in Washington took its toll on the dollar, sending it more than 2.2 percent lower against the yen in the past week. But it was flat against the euro, which was hit by its own debt concerns. The dollar lost against the Swiss franc and the Canadian dollar, as well as others.

Investors will be watching Europe in the week ahead, as spreads on peripheral sovereign bonds continue to widen against the benchmark. Moody's put Spain on review for downgrade Friday, driving investors into the safety of German bunds and Treasurys.

"This has been a sideshow to what's happening in Europe," said George Goncalves, Nomura Americas Treasury strategist. "The debt ceiling is important and it's important to get it fixed. It's a cathartic process. As painful as it is, the fact we are doing this means the better off we will be in three years time. It has been a distraction to us, and we're taking our eyes off the ball of what's going on in Europe. All of these spreads are widening. Even France is underperforming Germany in a big way."

Econorama

Expectations are not high for Friday's July jobs report, after two months of flat employment growth in May and June. Both months were surprisingly weak, with just 18,000 nonfarm payrolls added in June.

"We're in prayer mode to get something greater than 50,000," said Zane Brown, fixed income strategist at Lord Abbett. Brown said companies do not seem to be in the mode to hire. "Here we're going from a fiscal program of stimulus that's ending, and we're going to a fiscal program of austerity.

Friday's report of weak 1.3 percent growth in the second quarter and a sharp downward revision in first quarter growth to just 0.4 percent leaves little optimism for job growth. Barclays, as a result of the numbers, cut its third-quarter GDP forecast to 2 percent from 3 percent, and fourth-quarter to 2.5 percent from 3.5 percent.

"The GDP numbers were more or less what we expected for Q2," said Goldman Sachs economist Andrew Tilton. "But I think what kind of led the whole process was the revisions. ..They made the 2008, 2009 recession look deeper so that we haven't made it back to where we were pre-recession, where it previously looked like we had."

Tilton said Goldman expects 50,000 nonfarm payrolls in July, compared to the consensus which is closer to 100,000.

ISM manufacturing and construction spending data are due out on Monday. Car sales and personal income slated to be released Tuesday. ADP's private sector employment report and the Challenger report on layoffs are on the calendar for Wednesday. ISM nonmanufacturing data and factory orders are also out that day. Weekly jobless claims and monthly chain store sales are due Thursday, and consumer credit is expected Friday.

Earnings Central

The deluge of earnings news continues in the coming week, with about a fifth of the S&P 500 companies reporting, including Procter and Gamble, General Motors and MasterCard. Corporate profits have been proving a positive, with 73 percent of the S&P 500 so far beating earnings estimates, according to Thomson Reuters. But companies have been increasingly talking about uncertainty including about the outcome of events in Washington.

Monday's reports include Allstate, Humana, FMC, Vornado, Boston Properties and Lowes. Pfizer, Archer Daniels, Barclays, Coach, Duke Energy, First Energy, NYSE Euronext, Parker Hannifin, Marathon Oil, Hyatt Hotels and Molson Coors report Tuesday morning. CBS, Cephalon, Hertz, Vulcan Materials and Harris report after the bell Tuesday.

Comcast (CNBC's parent), Time Warner, Clorox, Constellation Energy, MasterCard, Owens Corning, Prudential Financial, Devon Energy, Sotheby's, Williams Cos, Dendreon, Zipcar and Tesla report Wednesday.

General Motors and Unilever report Thursday, as does PG&E, El Paso, Fortune Brands, Kraft Foods, First Solar, LinkedIn, Sunoco, Priceline.com, AIG and Southwest Air.

Procter and Gamble, Viacom and Allianz report Friday.

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