The standoff between Republicans and Democrats over "Obamacare" is currently unfolding. However, the real test will occur on October 17, when a decision on whether to raise the debt ceiling will need to be made. In the meantime, U.S. stocks are "oversold" at current levels and could rebound to 1700/1720 in the short term.
Head to head, once more
Pragmatism has not prevailed this time in Washington, D.C. and approximately 800,000 workers will be without a salary until a difficult compromise is reached on Capitol Hill. In the past 40 years, half of U.S. government shutdowns (around 17) have lasted less than three days. Even fewer of those were protracted for more than 20 days. The goal is to find a solution before October 17, when the federal government debt will reach its ceiling. Congress could, as an example, approve the spending bill for the period necessary to prevent additional problems in the near future and simultaneously increase the debt ceiling.
U.S. numbers are improving
In reality, the Federal deficit has fallen from approximately 10% of the Gross Domestic Product (GDP) in 2010 to almost 4% in 2013. The deficit is still $640 billion and needs further improvement; that is why a swift solution in D.C. is essential. As a result, 'prudence' is now the buzz word among investors. Stocks have contracted during the entire month of September, while the Treasury yields have again declined. These trends could be reversed in the short term as stocks are appearing oversold at current levels. A rebound of the S&P 500 index to 1700 - 1720 is possible, considering the favorable seasonal conditions for U.S. indexes during October. The U.S. dollar could also briefly rebound, but the trend for this year should stay on the downside. EUR/USD could hit 1.40 by December 2013.
Italy is still under the lens
Europe has avoided another major financial crisis. The Italian government, led by Mr. Letta, was able to confirm its mandate after winning a vote of no confidence last week. Stability will be necessary to continue with the economic reforms initiated by President Monti. Italy wants to keep its deficit below/near 3.0% this year and then gradually improve it after 2014. Considering its huge debt, interest rates must remain low because interest rates payments are around 5% of the GDP. It is a challenging, but not impossible, task and the decisive battle will take place in Roma's parliament. Unstable governments will not help the economy and rating agencies are watching the Italian political process very closely.
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