The Bigger Threat Than a US Government Shutdown

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Debt Ceiling

Most headlines today are focusing on the looming possibility of a government shutdown , but the economic impact of a short-term shutdown would probably be limited to modest dents in fourth-quarter economic growth and consumer confidence.

In fact, in my opinion, there's a much bigger threat to the market coming later in October.

As I write in my new weekly commentary , the more significant risk relates to the debt ceiling -the statutory limit on the amount of debt the United States is able to issue. The government is set to hit the debt ceiling, i.e. the current threshold of $16.7 trillion, in two to three weeks.

If Congress and President Obama cannot come to an agreement that would raise the debt ceiling before mid-October, the United States may technically default on its debt. Such a default hasn't happened before and would be massively disruptive to the global financial system, the economy and the country's financial reputation.

Looking forward, I do believe that even if Washington experiences a short-term shutdown, it will stumble toward a temporary solution on the debt ceiling. Still, there are a few near-term implications for investors.

  • Expect more volatility. While I believe that the current budget battles will ultimately be resolved, they are likely to cause more near-term angst for investors before a resolution is reached and are likely to be a short-term negative for stocks. As such, I expect the recent pickup in volatility to persist .
  • Get Defensive. Under the scenario I expect, investors should consider getting a bit more defensive, raising cash and looking at the accompanying volatility as a buying opportunity.
  • Don't Sell Gold Just Yet. Though I hold an underweight view of gold , the precious metal may be worth holding onto if you have a pessimistic view of how the budget battle will play out. If Washington fails to raise the debt ceiling, a technical default on U.S. debt would cause a significant blow to the global financial system. It would almost certainly cause a sharp pullback in stock prices and would be a negative for fixed income credit sectors. In fact, about the only asset class likely to be an obvious beneficiary of a debt ceiling breach is gold.

Source: Bloomberg

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog  and you can find more of his posts here .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Economy

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