More relieved than satisfied, markets will shift attention from Washington to the sluggish U.S. economy and Europe's debt problems.
After weeks of painful public haggling, the House of Representatives Monday evening approved a compromise bill that will raise the debt ceiling and reduce the deficit by $2.1 trillion over a 10-year period. The Senate is expected to approve the measure at noon Tuesday, and President Obama is expected to sign the bill following that vote.
Stocks Monday rose out of the gate, but lost steam and then fell hard after the July ISM manufacturing survey came in at a shocking 50.9, down from 55.3 the month earlier. ISM below 50 would have signaled economic contraction. The market ultimately regained momentum, after triple digit swings in the Dow, and closed just slightly lower as it became clear the House would approve the debt plan.
The Dow was down 10 Monday at 12,132 and the S&P 500 was off 5 at 1,286. The dollar gained 1 percent against the euro but fell to an all-time low against the Swiss franc.
The dollar ended the day higher against the yen, as wire reports said the Japanese government may want to intervene again to stop the yen's ascent. Japan's finance minister Yoshihiko Noda later called the yen overvalued and said he has been in close touch with European and U.S. counterparts on the yen's strength but declined to say if there would be intervention.
The dollar had been at 76.29 yen early Monday, its lowest level since joint intervention following the March 11 Japanese earthquake.
"Having rising rate expectations right after that intervention helped make the intervention successful," but there are not those expectations now, said Robert Sinche, head of global foreign exchange strategy at RBS. Sinche said he doubted central banks would intervene until after the debt ceiling package is fully approved on the outside chance it hit a snag, creating dollar volatility.
Sinche said the dollar could continue to come under pressure. "The cyclical numbers are pretty disappointing. July was supposed to a pretty good month. The ISM was a punch in the stomach. It was shocking," he said.
"Last week, we said we still think the cyclicals are okay, but the dollar got a yellow card because of the dragging out of this debt ceiling debate and the acrimonious nature of it. Now, it gets a yellow card for the fundamentals," Sinche said.
Treasury prices rose, and yields, fell in an inverse move on the weak data Monday. The 10-year finished the day with a yield of 2.753 percent, its lowest level since November.
"Regardless of what happens, Treasurys are going to rally. It's a 'Heads, I win — Tails, I win' trade that's driving it. It's these external things and the weak economic backdrop," said Abdullah Karatash, head of U.S. Fixed Income Credit Trading at Natixis.
Traders have also been speculating that Standard and Poor's will now move ahead at some point with its threatened downgrade to the AAA credit rating of the United States. S&P has said it would want to see $4 trillion in cuts, and the compromise bill falls short. Moody's is expected to give the U.S. more time, based on its statement from last week.
"That's going to be the market's next obsession. Now that we have a deal, do we still get downgraded?" said Karatash. "At the end of the day if the U.S. government gets downgraded, then AA is going to be the next AAA. How many governments are AAA and have better balance sheets? Canada? Norway? But their markets aren't deep."
"It could be an ugly August," he said. "On the back of it, I think the Treasury trade is probably one of the more interesting trades. Treasury prices have risen during the course of the debt feud in congress, as investors sought safety.
Monday's stock sell off saw its worst moments around the European market close, just before midday New York time. Art Cashin, director of floor operations at UBS, said the declines in European markets were one of the reasons that drove U.S. stocks to the day's lows.
"We'll go back to looking at Europe," he said, adding traders will also be watching all the jobs-related data in the walk up to Friday's July employment report. ADP private payroll numbers are released Wednesday.
Spreads on peripheral European sovereign debt widened Monday, and Italian and Spanish bonds were particularly hard hit. Italy's Milan bourse fell nearly 4 percent and the Madrid stock market was off 3.2 percent. Euro zone markets, worried about sluggish U.S. data, had their own weak PMI Monday ,at 50.4, from 52 in June.
"I think the fixes (for the European debt problems) are getting each one more short-lived than the previous," said Sinche.
"You're just not getting that much longevity out of these policy initiatives. The other thing is obviously economic growth fixes a lot of things. Economic slowdowns complicate a lot of things. The fixes go a lot more smoothly if there's strong global growth. The concern is you're going to get more slowing of economic momentum," he said.
As traders try to gauge the impact of a U.S. credit rating downgrade, some are pointing to other AAA credits that may also be downgraded. "If the U.S. gets downgraded, I think there will be a whole raft of other downgrades, and I think it will hit the European space, not specific to one country but across the board," said Karatash.
Sinche said he doesn't necessarily expect other downgrades tied to a U.S. downgrade, but if the U.S. rating is cut, it might bring a new level of review that could lead to further downgrades. "If downgrading the U.S. brings about a renewed focus on fiscal sustainability of other places around the world, then you come to the same conclusion. It may be there's a harder line taken on fiscal sustainability going forward," he said.
What to Watch
Tuesday's U.S. data includes monthly auto sales and personal income at 8:30 a.m.
There are dozens of earnings reports, including Pfizer, Toyota, Barclays, Duke Energy, NYSE Euronext, Molson Coors, Archer Daniels, Emerson Electric, Cognizant, Hyatt Hotels, Foster Wheeler and Rowan Cos, all ahead of the New York market open. CBS, Cepahlon and Hertz report after the closing bell.
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