Markets show a glimmer of optimism

The Asian markets opened sharply higher as news of a deal between President Obama and congressional leaders emerged. The Asian markets opened sharply higher as news of a deal between President Obama and congressional leaders emerged. (Jewel Samad/ AFP/ Getty Images)
By Todd Wallack
Globe Staff / August 1, 2011

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Economists and financial analysts were encouraged yesterday by news that political leaders had reached a tentative deal to avoid defaulting on the nation’s debt, a crisis that has roiled the stock market in recent weeks and further weakened the fragile US economic recovery.

Analysts said the markets will probably receive a boost today from President Obama’s announcement last night that a deal had been struck between congressional leaders and the White House. The Asian markets opened sharply higher last night, and futures in the Dow Jones industrial average - an indicator of how the market will open - surged nearly 170 points as of 10:30 p.m. yesterday.

The deal also seemed to somewhat calm other indicators: the dollar strengthened 1.1 percent against the yen and 1 percent versus the Swiss franc, and gold lost as much as 1.3 percent to $1,607.45 an ounce after rising for weeks.

But investors will probably still remain anxious until a final deal - which requires passage by the House and Senate - is completed. And the stock market could be roiled again if Wall Street is concerned about the details in the agreement or if the pact is voted down in Congress.

“The devil is in the details,’’ said Eric Stein, a portfolio manager for Eaton Vance Corp., a prominent Boston mutual fund company. “People are scared and pulling back from the market.’’

Without an agreement, the White House has warned that it will run out of money to pay its bills starting tomorrow, potentially forcing it to stiff everyone from creditors to Social Security beneficiaries. The government has yet to spell out exactly how it would continue to operate, though most observers expect the government would probably continue to make the interest payments on its debt and make drastic cuts elsewhere; overall, it would have to cut nearly half of federal spending.

On Friday, the Dow Jones Industrial Average fell nearly 100 points, the sixth straight decline, and the Dow Jones recorded its largest weekly loss in more than a year. Moreover, a national survey by UBS Wealth Management Americas last week found 40 percent of clients said they would not invest money in the markets until Congress resolves the debt ceiling issue. In addition, a UBS analyst said many business owners and consumers are also wary of making any major purchases with so much uncertainty in Washington over the issue, creating yet another drag on a sluggish economy.

“We increasingly think that the [debt discussions] have an impact on the real economy,’’ said Katie Klingensmith, a UBS economic and policy analyst, adding that people are “quite worried’’ about the possibility of a default. “Not only had the worry been high, it’s become increasingly personal,’’ referring to consumers’ decisions to forgo major decisions like buying a home.

Many investors have even been spooked about holding money in money market mutual funds, traditionally one of the safest havens for cash, because many hold US Treasuries and other government debt. Investors yanked more than $37 billion from money market funds in the week that ended Wednesday, the largest outflow this year, according to the Investment Company Institute, an industry group.

Even if the United States avoids defaulting on its debt, the country could still lose its pristine AAA credit rating if major credit rating agencies are not convinced the compromise will adequately address the country’s long-term budget challenges. A lower credit rating could increase interest rates, making it more expensive for the government and many Americans to borrow money, and further erode the value of the US dollar.

Standard & Poor’s recently said it wanted to see the government agree on at least $4 trillion in cuts or tax increases to narrow the deficit, at least $1 trillion more than the deal outlined last night. Some say the partisan bickering in Washington over raising the debt ceiling has also reduced confidence in the country’s ability to tackle the deficit and other major issues.

“If they are able to pull this off - and avoid a technical default - this would allow the US to dodge a bullet,’’ said economist Michael Goodman, a professor at the University of Massachusetts Dartmouth. “We’ve had a lot of close calls in the last couple days. Hopefully, a compromise will be reached in time.’’

But the crisis and partisan bickering in Washington has taken a toll, Goodman said. “There still may be a price to pay for this manufactured crisis,’’ he said.

In addition, economists say any spending cuts included in the deal that take effect immediately would probably drain some money from the US economy and could slow the recovery, despite the widespread agreement that political leaders need to do something to balance the budget in the long term.

And the federal spending cuts could have a particularly significant impact on Massachusetts, because the state receives an unusually large portion of defense contracts, scientific research grants, and other federal aid. The state is home to major defense contractors such as Waltham-based Raytheon Co., and some of the country’s most prestigious research universities and medical centers.

“You can expect that at some point soon we will feel the negative impact of these cuts,’’ Goodman said.

The crisis comes at a time when economists and politicians alike were already disappointed with the country’s sluggish growth - an annual rate of less than 1 percent in the first half of 2011 - and stubbornly high unemployment rate, which remains above 9 percent. While the Massachusetts economy has fared better, a national slowdown would eventually hamper growth here.

Economists said the damage would become many times worse if Congress does not approve a deal, raising the possibility that the US will default on its obligations for the first time in history.

Analysts warn the markets would probably tank, the cost of borrowing could increase significantly, and US spending could shrivel, increasing the risk that the United States slides back into recession.

“Unless lawmakers raise the nation’s debt ceiling in the next few days, financial markets will crack and the recovery will unravel,’’ warned Mark Zandi, chief economist at Moody’s Analytics, a forecasting firm in West Chester, Pa., in a piece he released yesterday. “A default on US Treasury debt obligations would be catastrophic for the global financial system.’’

Todd Wallack can be reached at