Markets Slide on U.S. Budget Moves

Global Stocks Slide Amid Concern Over U.S. Budget

By DAVID JOLLY 10:29 AM ET

Global stocks fell on Monday on concerns about the budget showdown in Washington and a growing political crisis in Italy, with a nearly 1 percent loss on Wall Street at the start of trading.

 

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Investors are worried that even a temporary government shutdown could put a damper on an already weak economic recovery.

Stock markets fell worldwide on Monday as political disagreements in Washington made a shutdown on Monday night increasingly likely.

The Standard & Poor’s 500-stock index was down about 0.5 percent in trading at midday. Leading indexes were down 2.1 percent in Japan, 1 percent in Germany and 1.3 percent in Italy.

European stocks were under additional pressure because a growing political crisis in Italy is threatening the government there.

In the United States, investors are most concerned that a government shutdown this week could make it more likely that the United States will default on its outstanding debt when it reaches its borrowing limit later this month.

But on Monday, economists were scrambling to estimate the more immediate effect on the economy if all nonessential government services are closed on Tuesday.

While many economists have said that the direct blow to the economy would be relatively modest if a shutdown lasted only a few days –- as past shutdowns have -- the political battles could also deliver a blow to confidence.

“The hit to consumer and business confidence from such an outcome could be substantial, increasing the shutdown’s effects,” Gennadiy Goldberg, a United States strategist at TD Securities wrote to clients on Monday.

Any hit to spending would be problematic because economic growth has already been more sluggish than most policy makers want. The Federal Reserve determined recently that the economy was too weak to withstand even a small reduction in the central bank’s stimulus efforts.

The Fed chairman, Ben S. Bernanke, said during his press conference on Sept. 18 that the budget battles could make matters worse.

“I think that a government shutdown — and perhaps, even more so, a failure to raise the debt limit — could have very serious consequences for the financial markets and for the economy, and the Federal Reserve’s policy is to do whatever we can to keep the economy on course,” he said.

The fears about a government shutdown are overshadowing a few recent indicators that the economy may have been strengthening before the current fighting in Washington. Manufacturing activity in the Chicago area picked up more than expected in September, according to a private index released on Monday morning.

As the negotiations in Washington continue, many strategists are closely watching the market for United States Treasury bonds. If the government does move closer to defaulting on its debt, investors might be expected to sell off their Treasury bonds. But last time the government approached the debt ceiling in 2011, investors counter intuitively piled into Treasury bonds, treating them as an unexpected safe haven.

On Monday morning, traders first sold 10-year Treasury bonds, but then began buying later in the day, pushing the yield on the bond up to 2.63 percent from its closing level of 2.62 percent on Friday.

The dollar was little changed against other major currencies.

Derek Halpenny, head of global markets research at Bank of Tokyo-Mitsubishi UFJ in London, said the currency market had remained calm in the face of the budget battle.

“Markets can handle the prospect of a government shutdown starting tomorrow,” Mr. Halpenny said. “But if there’s no resolution on the debt ceiling negotiation by Oct. 17, when the government tells us they’ve run out of money, that’s a different proposition. Then you could really get into a panic situation.”

In the short term, he said, the conflict might help to weaken the dollar because investors had been expecting American interest rates to rise. A sharp decrease in government spending would hurt economic growth and probably lead the Fed to hold off on its plan to curtail its monthly bond-buying program, a component of its monetary stimulus plan that holds down rates.

While the game of chicken in Washington was foremost in investors’ minds, Europe had a sudden flare-up of an

The yield on the Italian 10-year bond rose 9 basis points, to 4.5 percent Monday, after the political party of the billionaire former Prime Minister Silvio Berlusconi shook the government over the weekend. The yield later in the day slipped back, up only 3 basis points.

Five ministers of Mr. Berlusconi’s People of Liberty party resigned from the cabinet, leading Prime Minister Enrico Letta to call for a confidence vote to be held this week. A failure to win that vote, which will probably be held Wednesday, could lead to the collapse of his governing coalition.

Europe has managed to keep politics mostly on the back burner for months, since the European Central Bank said last year that it would do whatever was necessary to support embattled governments, including buying their bonds outright, as long as they enacted important measures to right their finances. Without a functioning government, though, Italy might not be able to meet the E.C.B.'s conditions.

The Italian turmoil “could potentially cause a new wave of euro crisis,” Holger Schmieding, chief economist at Berenberg Bank in London, wrote in a note.

The major effect of the European Central Bank’s bond-buying announcement, Mr. Schmieding said, has so far been to reassure investors that support would be available even for Italy, the third-largest euro zone economy after Germany and France. A collapse of the government there might cause them to lose faith in that backup plan, and the resulting sell-off could “hit business and consumer sentiment across Europe, dampen the nascent recovery and prolong the period of economic pain for the stricken euro periphery.”

Inflation data from the euro zone Monday suggested the E.C.B. has additional room to cut its benchmark interest rate from the current 0.5 percent. The central bank holds its monthly governing council meeting on Wednesday.

A first estimate of September consumer prices from Eurostat, the statistical agency of the European Union, showed inflation rising 1.1 percent.

By the E.C.B.'s definition, price stability is achieved when inflation is just below 2 percent.

Mr. Halpenny said the latest figure “must be at the very bottom of their acceptable range,” raising the risk of deflation. He said Mario Draghi, the European Central Bank president, and his colleagues on the bank’s governing council would probably not announce a rate cut after their meeting Wednesday, but that Mr. Draghi “could give a quite dovish outlook to set the market up for a cut in November or December.”

old ailment: Italian politics. 

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