Confusion Grips Wall Street

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finance.yahoo.com

With no resolution in sight to lift the debt-ceiling, investors are scrambling to find ways to hedge themselves against what was once unthinkable: A U.S. debt default and loss of triple-A rating.

Further spooked by Friday's shockingly weak GDP report, the stock market appears headed for a sixth-straight decline. In recent trading, the Dow was down 0.4% but off its earlier lows.

As discussed here earlier this week, concern about Washington's dysfunction has been evident in a variety of markets, notably gold's continue strength, the rising cost of U.S. credit default swaps and the dollar's weakness vs. the yen and Swiss franc. Meanwhile, the CME now says it won't accept short-term Treasuries as collateral while The WSJ reports the $4 trillion repo market is at risk if the U.S. loses its triple-A rating.

But there's a lot of confusion on Wall Street about how to plan for Aug. 2, as The WSJ's Greg Zuckerman and I discuss in the accompanying clip. This confusion is evident, most notably, by continued strength in U.S. Treasuries. In recent trading, the benchmark 10-year note was up 26/32, its yield falling to 2.85%.

"Treasuries are fascinating," Zuckerman says. "Do you sell them or do you buy them?"

On the surface, it seems illogical for traders to be buying the debt of an entity (the U.S. government) that is threatening to default. But the government has said making debt payments will be a priority; and if Congress does agree to a deal to slash government spending, that will likely put further pressure on an already weak economy, which is a bullish scenario for Treasuries.

As the week comes to a close, the conventional wisdom remains that "in the eleventh hour, [Congress] will come up with some compromise," as Zuckerman puts it. That view is preventing panic on Wall Street, which is a good thing. But the lack of market panic means there's less pressure on Congress to reach a compromise before the Aug. 2 deadline, creating a chicken and egg conundrum.

Confused? You're not alone.