Markets had a rocky week as the August 2 debt-ceiling deadline came ever closer with no deficit-reduction deal in sight. We still believe that an actual debt default ? non-payment of interest or principal on Treasury securities ? is extremely unlikely, but beyond that it's very hard to know how the drama will play out. In the long-term Treasury market, weak economic data is trumping any fears of debt default, as 10-year Treasury yields fell steeply to around 2.8%.
The weak GDP figures (both for Q2 itself and for previous quarters through downward revisions) combined with a disappointing durable goods report and a soggy Fed Beige Book to show an economy crawling forward with little momentum. Even if the debt standoff is resolved quickly this week, the extreme uncertainty will surely already have damaged third-quarter growth by hurting consumer and business willingness to hire and spend.
Economic data will take a back seat to the Washington circus at the beginning of the week, as leaders on Capitol Hill will try to stitch together a compromise deal that can pass both Houses and get the President's signature. But we may find that the drama will extend beyond the August 2 "deadline". A temporary debt-ceiling extension pending a final deal is possible. And since the Treasury's cash balances appear better than had been expected, the "true" deadline is probably not August 2 but maybe a week or more later, even though the administration has not acknowledged that.
We don't expect a let-up in the stream of soft economic reports this week. The highlights include the ISM manufacturing index for July (Monday). This index surprised on the upside in June, but we expect it to slip back this month. Personal income and consumption for June (Tuesday) is expected to reinforce the bleak picture for incomes and consumption in the Q2 national accounts. But the main report of the week will be for employment, on Friday, and even though we don?t expect such a weak report as in June, we look for another month of sluggish private employment growth and declining government employment.
