On Tuesday, Wall Street succumbed to the first real panic selling we’ve seen since the Fed started its open-ended “QE3″ stimulus late last year.
In the end, the Dow Jones Industrial Average lost 1.1%, crude oil gained 0.3%, Gold gained 0.2%, and the U.S. Dollar lost 0.4%.
Yep, the shutdown is still on. And we’re still barreling towards the Oct. 17 debt ceiling deadline. But the real catalyst the seemed to slap the market across the face was turmoil in the short-term Treasury bill market as one-month yields surged to levels not seen since 2008 — in the midst of the financial crisis — as investors worry upcoming interest and principal payments might not be made on time.
It didn’t help that President Obama and House GOP Speaker Boehner are increasingly entrenched in their respective “no negotiation” vs. “no clean budget extension” positions. This afternoon, Boehner roared that Obama was asking for “unconditional surrender” as a prerequisite for coming to the negotiating table.
Click to Enlarge Of course, the truth is a little more complicated (Republicans have been waiting to hold negotiations until now to maximize leverage on Democrats). But the point is these folks don’t like each other. And they are making it difficult to come to an agreement without one party coming out the clear loser. In the art of realpolitik, that’s a mistake.
The bond market is finally figuring out that there could be real consequences if we hit the debt ceiling and the U.S. Treasury finds itself unable to pay its obligations on time.
In fact, the situation has become so unsettled that banks can now borrow short-term funds at a lower cost than the U.S. government can: The 1-month LIBOR is at 0.17% while the one-month Treasury bill traded at 0.35% today.
This may not seem like much, but given the size and importance of the short-term T-bill market, it’s a big deal.
The short-term Treasury bill market provides the liquidity that the financial system runs on. Volatility there will have a cooling effect on inter-bank lending, brokerage operations, and a whole slew of other activities. The 2011 stock-market selloff really didn’t get going until short-term Treasury bill yields surged, rising from near 0% to a peak near 0.12%.
Click to Enlarge We’re already well above that now. And that’s why stocks finally got unceremoniously knocked off their perch. The Dow seems to have fallen through the neckline of an imperfect head-and-shoulders reversal pattern — a pattern that carries a price target of around 13,380. That would take us all the way back to the December highs for a 6%+ decline from here and a total peak-to-trough decline of 12% from the September high.
Fasten your seatbelts, things are about to get exciting.
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