The muted market reaction to this week’s budget deal in Washington may initially seem like a disappointment. After all, uncertainty over government spending, debt and taxes has consistently emerged in business sentiment surveys as the biggest single factor holding back corporate investment and damaging financial confidence. Why then did Wall Street celebrate this breakthrough with its biggest daily fall in two months?
Nobody should be surprised that Wall Street hit new records this week. After all, the U.S. has just witnessed the end of a sensational hostage crisis that was threatening national security and undermining economic confidence — and even more sensationally, this was the second such crisis in two months.
So far, the battle of the budget in Washington is playing out roughly as expected. While a government shutdown has theoretically been ordered, nothing much has really happened, all the functions of government deemed essential have continued and financial markets have simply yawned. The only real difference between the tragicomedy now unfolding on Capitol Hill and the scenario outlined here last week has been in timing. I had suggested that the House Republicans would give way almost immediately on the budget, if only to keep some of their powder dry for a second, though equally hopeless, battle over the Treasury debt limit. Instead, it now looks like President Obama may succeed in rolling the two issues into one and forcing the Republicans to capitulate on both simultaneously.
Now that the worldwide panic over U.S. monetary policy has subsided, Washington is brewing another storm in a teacup: the budget and Obamacare battle that reaches a climax next Monday, followed by the debt limit vote required to prevent a mid-October Treasury default. The ultimate outcome of these crises is a foregone conclusion. As Senator John McCain told the press this week: “We will end up not shutting down the government and not de-funding Obamacare.” He could surely have added that a Treasury default is also out of the question.