Budget Battle Key To Stock Trends Markets Pin Hopes For Rebound On Successful Budget Talks
The U.S. government has been running a deficit for 30 years. So why has the stock market suddenly started worrying about it?
It’s a salient question, following the market’s plunge last week, blamed largely on the inability of President Clinton and the Republicans to agree on a budget-balancing plan.
It’s also important one for average Americans, since the ups and downs of stocks can have a profound affect on the overall economy - influencing what we earn and spend even if we don’t invest.
Some questions and answers about the budget stalemate’s impact on the markets and the rest of us.
Q: Why do the financial markets care about the stalemate in the budget balancing talks?
A: Economic growth has been sluggish of late and the markets are worried. New jobs are growing at half the pace of a year ago. Consumers are spending less - witness the slack rate of retail sales this Christmas and the rebates that have suddenly emerged from car companies. The markets are hoping a budget deal will help turn the economic tide.
Q: How would a budget deal help the economy?
A: If the budget is balanced and the government spends less, it will issue fewer U.S. bonds to borrow money. With less demand for credit by the government, consumer interest rates for everything from houses to cars to VCRs could go down. That makes borrowing cheaper, stimulating more spending by consumers and companies for business expansion.
Q: What happens without a budget deal?
A: Investors in U.S. bonds have been counting on a deal to reduce interest rates, since that increases the price of their holdings. Without a deal, many may sell their holdings, forcing the price of bonds down and interest rates up. “If we continue to have interest rates rising amidst a flat economy, then recession risks will increase,” said John Lonski, senior economist with Moody’s Investor Service in New York.
Q: So does the collapse of a budget deal ensure a recession?
A: No. Economists say the Federal Reserve Board is likely to step in and push interest rates downward on its own, no matter what the politicians do. This should stimulate economic growth and be a psychological lift to the stock and bond markets.
Q: So the crisis isn’t as bad as it seems, right?
A: Yes, but with one big if. In order to put pressure on Clinton to agree to their deficit reduction plans, Republicans have refused to raise the federal debt ceiling - a cap on how much the government can borrow.
If the government runs out of cash and defaults on some of its bonds, investors will demand sharply higher interest rates to compensate them for increased risk.
“If there are any cardinal sins on Wall Street, default is one of them,” said David Blitzer, chief economist with Standard & Poor’s Corp.