Market complacency: With just six days left until America's doomsday debt deadline, investors are convincing themselves that a US credit downgrade won't be such a big deal after all. Sure, a rating cut, which S&P sees as a 50:50 chance - would hit the dollar and push interest rates up higher. It would also send stocks tumbling, with Wednesday's near-200 point drop in the Dow a reminder of its market-moving potential. But there's a growing consensus that financial markets can handle it, with any dislocations it causes short-lived. That may be true.
Yet, this complacency is predicated on a one-notch downgrade - most likely from Standard & Poor's, which has tied the U.S. rating to its ability to hammer out a credible deficit reduction plan. If S&P does pull the trigger, it would most likely just knock one rung off the United States' credit ladder in its initial salvo. But that doesn't mean its job would be done.
If there are no death-defying swoons like the almost 700-point spiral in the Dow in 2008 when Congress initially blocked the bank bailout or 100 basis-point spike in U.S. yields, hardliners are sure to dig in deeper. If there are no real-world consequences, why compromise? That could push serious deficit reduction once again off into the future, making eventual pain even greater and future cuts more likely. Greece's rapid decline from single-A in 2009 to near default should serve as a cautionary tale.
The United States is not Greece, but is it far from Japan? Japan is rated AA-minus, a rating that would have far more serious consequences if applied to the United States. It's one of those lines in the sand where conservative investors start to seriously rethink their holdings. It would also put big banks in the crossfire, since their ratings, which enjoy a sizable lift from the government's implicit support, could also get hit.
The White House and Congress probably will hammer something out before the government runs out of money next week, but at this late hour it's hard to see them agreeing to a meaningful plan that safeguards the United States and financial markets from far greater pain in the not-too distant future.
