US markets finally fall on debt ceiling fears

capitol building on screen in front of new york stock exchange floor US markets fell on fears of a prolonged government shutdown

After largely shrugging off the first few days of a US government shutdown, US markets finally fell due to worries over Washington gridlock.

The Dow Jones Industrial Average, S&P 500, and Nasdaq all closed down by close to 1%.

The decline followed the release of a report by the US Treasury warning of the "catastrophic" impact of a failure to raise the nation's borrowing limit.

The debt ceiling must be raised by 17 October to avoid a debt default.

Analysis

After what seemed like a muted reaction by investors earlier this week, US shares fell sharply on Thursday.

Traders on the floor of the New York Stock Exchange say the ugly drama that is taking place in the capital is definitely affecting the sentiment.

Their bigger concern is the debt situation - if US lawmakers can agree to raise the limit in time to avoid the government defaulting on its debt.

Today's report by the Treasury said a possible default would be "unprecedented and has the potential to be catastrophic" which is affecting the psychology of the markets.

But there is still a little hope. House Speaker John Boehner said that he won't let the nation default.

That has led to a small rebound in share prices as an indication of their fragile optimism.

The Dow Jones index fell 136 points, closing below 15,000, after surpassing the symbolic milestone on 9 September.

The Nasdaq closed down 40 points and the S&P 500 fell 15 points.

"Credit markets could freeze, the value of the dollar could plummet, US interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse," warned the Treasury report.

It said that if this were to happen, the impact could last for "more than a generation."

Separately on Thursday, IMF managing director Christine Lagarde said it was "mission critical" that the US agrees a new debt ceiling.

Most observers assume that Washington will be able to come to an agreement before the 17 October deadline, but as the shutdown drags on, there is a real worry that a prolonged closure could impact debt ceiling negotiations.

'Danger zone'

Already, the cost of US borrowing in the short term has increased.

The US government is essentially paying less to borrow for six months than it is paying to borrow for one month.

This is widely taken as an indication that investors are worried about the near-term prospects of a US debt default on 17 October, which would put the security of one-month Treasury bonds in doubt.

Some bank analysts have termed the next month the "debt ceiling danger zone".

The current shutdown is costing the US economy an estimated $300m a day.

According to Goldman Sachs, it could shave as much as 0.2% from GDP each week the government is closed.

Ruining the good name of the US
Ben Willis on NSYE Benedict Willis says he believes that US politicians will reach an agreement

"The fact that they used the word catastrophic is not helping the psychology of the markets," trader Benedict Willis told the BBC from the floor of the New York Stock Exchange, commenting on the US Treasury's report.

Mr Willis said he thought Thursday's decline was partly due to news out of Washington, and also partly due to a larger correction relating to the Federal Reserve's decision to continue its extraordinary efforts to prop up the US economy.

On 18 September, Federal Reserve chairman Ben Bernanke said the central bank would continue its policy of quantitative easing due in part because the US economy was slightly weaker than it had thought, and also because the bank worried about "fiscal headwinds" from Washington squabbling.

Dow Jones Industrial Average

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Mr Willis said that while the shutdown was of concern, "the debt ceiling is the most important part."

"The rest of the show that they're putting on in front of the cameras in Washington is just something to keep the viewers busy."

Mr Willis said he and his fellow market participants "fully anticipate" that Congress and US President Barack Obama will come to an agreement to avoid a historic default.

He says Congress should not be in the position "to impact the good name of the US in the marketplace."

'A very long fight'

Elsewhere, and the Washington gridlock was the main topic of conversation on European markets.

In the UK, where the FTSE 100 index of leading shares closed the day up slightly, analysts predict increased volatility as the shutdown continues.

IMF head Christine Lagarde says it's "mission critical" that the situation is resolved

Justin Urquhart Stewart of Seven Investment Management said European markets were holding off placing any "big bets", adding, "markets will get more and more volatile."

On the West Coast, Chris Orndorff, senior portfolio manager at Western Asset Management said that there is both increases sensitivity in the markets, and increased uncertainty, and that European markets could follow suit.

"I would expect the UK to trade in sympathy with the US on Friday," he said.

Some of the biggest losers on the US markets by Thursday afternoon were Visa, which dropped 3&%, and the investment banking giant Goldman Sachs which shed around 2%.

Mr Orndorff added that market-watchers are "expecting greater volatility" until the situation is resolved.

"This could be a very long fight" he said.

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