THE BASIS POINT

WeeklyBasis 7/17: Rate Reactions To Debt Ceiling

Rates were down slightly last week but there’s reason for caution coming into this week: there’s no deal yet on U.S. budget proposals and until there’s a budget agreement, the U.S. debt ceiling won’t be raised.

The U.S. will reach its borrowing limit August 2, but it takes time to process legislation and money flows needed to raise the debt ceiling, so the target deadline is to agree on a budget by this Friday, July 22. If a deal is reached this week (or next), stocks are likely to rally and bonds would sell, pushing rates up. Below is a recap of last week and preview of this coming week.

Recap of July 11-15 Week
Rates dropped last week on weak economic data: Retail sales down, trade deficit spiked, consumer sentiment plummeted, manufacturing (Empire State) weakened, consumer and business inflation flat, European bank stress tests showed vulnerability, and Moody’s and S&P threatened to downgrade U.S. credit ratings if lawmakers don’t raise the debt ceiling.

During his two-day Congressional testimony last week, Fed chairman Ben Bernanke first said Fed would do whatever’s necessary to help fragile recovery, then took a harsher stance so markets don’t make false assumptions about more quantitative easing.

Here’s every economic stat from last week broken down by day—and we do this every day.

Preview of July 18-22 Week
There are key housing reports throughout this week: July homebuilder confidence Monday, June housing starts and June building permits Tuesday, June existing home sales Wednesday, and May FHFA home prices Thursday—this includes homes that have Fannie/Freddie mortgages.

We also have usual mortgage applications volume Wednesday which has been weaker lately and could mean we see weaker home sales (also Wednesday), a Fed survey of manufacturing activity in the Philadelphia area Thursday, and weekly jobless claims Thursday.

Also the debt ceiling budget battle will be center stage. There are lots of theories on market reaction to this, but there are two main views worth sharing:

(1) One theory says rates will spike if no debt ceiling deal is reached because ratings agencies will downgrade U.S. debt. But U.S. Treasury and mortgage debt is still the preferred safe haven trade in a questionable global debt picture. So ironically, Treasuries and mortgages could rally further in a debt ceiling impasse, pushing rates down.

(2) As noted above, stocks could rise if a debt ceiling deal is reached. If so, rates would rise as Treasuries and mortgages sold on stock strength.

The most probable scenario is number two. Combine this with next week’s housing data which should keep rates flat because the data are likely to reveal continued economic headwinds, and rates should be even to up slightly.

Volatility will continue and it’s hard to predict rates, so remember last week’s discussion on handling rate volatility.

And here’s all you may need to know on timing a debt ceiling deal.