How will the market react to a supercommittee “failure?”

As the deadline looms for the supercommittee to report back to Congress, some have raised the specter that “failure” would lead to a collapse in financial markets. For example, Massachusetts Sen. John Kerry has expressed concerns that a failure to reach an agreement would send a dangerous signal to markets, and the Committee for a Responsible Federal Budget has said that a “go big” agreement is needed to “reassure markets about our ability to repay our creditors.”

These concerns are misplaced.

First, even if the supercommittee fails to find an agreement, there would still be a $1.2 trillion 10-year spending reduction put onto the books via a process called sequestration that would limit annual appropriations by Congress. From a pure deficit-reduction perspective, a $1.2 trillion agreement would be no different than a so-called failure. Congress can of course revisit those cuts, but they could also revisit any other kind of spending agreement too.

Second, remember that financial markets are forward looking and respond primarily to unexpected news. Does the market believe that Democrats and Republicans will come together in a Kumbaya moment to pass $3 trillion in tax increases and/or cuts to spending? I wouldn’t bet on it. Goldman Sachs noted in a recent Q&A on the supercommittee that, “a ‘grand bargain’ to resolve this imbalance appears to be a low probability this year. Instead, the politically realistic outcomes range from no agreement to a deal reaching $1.2 trillion in deficit reduction over 10 years.” They also note that just “32% of economists polled in the November Blue Chip financial survey expected a super committee agreement to become law.” Thus a failure would merely confirm market expectations, and there should be little reaction in the markets.

Third, as I noted in an earlier post, real interest rates on federal debt are negative for some maturities, and very low for longer term bonds. There is no indication that markets are worried about U.S. debt and need to be reassured. For example, Moody’s rating agency recently stated that, “failure by the committee to reach agreement would not by itself lead to a rating change.”

Finally, the main worry for businesses is the lack of demand for their goods and services and the main worry for individuals is the lack of jobs. The markets would react if Congress fails to continue a payroll tax holiday or fails to continue unemployment insurance payments. The real, immediate crisis is jobs and economic growth – Congress needs to focus on getting people back to work. A jobs-first focus would, more than anything else, reassure markets that the U.S. economy is poised for growth, and not slipping into premature, job-killing austerity.


  • Unknown

    I have no basis for this and although this is a very logical analysis, it seems the high volatility index would be another factor that could create a larger negative swing even though the market may already largely predict it.