Deal or no deal? Markets bracing for Monday

DAVID K. RANDALL - AP Business Writers,JONATHAN FAHEY - AP Business Writers

Investors around the world remained on edge Sunday as Congress continued to work on a deal to raise the federal government's borrowing limit and avoid a possible U.S. debt default.

Japan's benchmark Nikkei index was the first major stock market to open for trading at 8 p.m. Eastern time on Sunday. In the first 20 minutes of trading, the Nikkei was up 1.3 percent.

There's also evidence that investors believe a deal will be finalized before U.S. markets open Monday.

By 8:30 p.m., about two hours after Senate Majority Leader Harry Reid said he had signed off on a pending agreement reached late Sunday between the White House and Republican leaders, Dow futures were up 163 points, or 1.5 percent. Future contracts for the broader S&P 500 index rose 1.3 percent. When futures are up during off-hours trading, stocks typically rise when the market opens.

If a deal is reached to raise the borrowing limit, John Brady, a senior vice president for futures and options at MF Global believes "stocks will rally, and stocks will rally big."

"The markets are giving heavy odds that this deal is going to get done," Brady said Sunday.

Jack Ablin, chief investment officer at Harris Private Bank in Chicago, said even a tentative agreement could lead to at least a 200 point rally for the Dow.

A deal would remove a major source of something investors hate: Uncertainty. But there's another reason a so-called relief rally might be a big one. Companies have reported strong quarterly earnings in the past few weeks. But traders have been reluctant to buy stocks on the good news fearing the debt wrangling in Washington might set off a financial crisis.

If there is no agreement to raise the nation's borrowing limit and defuse the building financial crisis, analysts said Sunday that they expect stock markets across the globe to fall on Monday.

In the U.S. that would add to six straight days of stock losses. The Dow Jones industrial average fell 581 points, or 4.6 percent, in that time.

Brady predicts the S&P 500 could fall as low as 1,200 in the next two days if there is no deal before the market opens Monday. That would be a 7 percent drop from Friday's close of 1,292 on Friday. The S&P was down 3.9 percent last week. A loss of another 7 percent would send the S&P down to a level it hasn't reached since last November.

The Treasury Department has said that after Tuesday the U.S. government won't have enough money to meet all of its financial obligations if Congress doesn't raise the nation's debt ceiling. If a deal isn't reached, the Treasury Department will have to decide which bills to pay and which to delay. Among them: interest payments on bonds, salaries of federal employees and Social Security payments to retirees. The Treasury Department has not indicated which payments will take priority if the debt ceiling is not raised.

Thomas Tzitzouris, head of fixed income research at Strategas Research Partners said Sunday that to avoid a steep decline, the market needs to at least see some progress toward a vote on a deal to raise the borrowing limit.

If not, he said: "That would be a double whammy. When (Congress says) there is progress and then there isn't, that really spooks the market."

That's what happened last week when a series of proposals gave investors hope there would be a deal. But one party shot each one down. Nearly every measure of market confidence fell last week as Tuesday approached without a deal. Gold, which tends to rise when investors aren't confident about other investments, rose 2 percent last week. A measure of stock market volatility, the VIX, jumped 6 percent.

In turn, the yield on the 10-year Treasury note sank to its lowest level of the year on Friday, 2.80 percent. Treasury yields fall when demand for them goes up. And demand tends to rise when investors are worried and want a safe place to put their money. Treasury bonds have long been considered the world's safest investment and are a top holding of the largest pension funds in the U.S., millions of Americans who own mutual funds and many foreign governments.

"If this issue can be taken out of the headlines and the focus on Washington can be redirected toward corporate earnings and economic fundamentals, the market will have removed a significant obstacle," said Quincy Krosby, chief market strategist at Prudential Financial.

Corporate earnings have been strong so far for the second quarter. Many major U.S. companies have reported their earnings in the last three weeks and others such as consumer goods companies Procter & Gamble and Kraft Foods will report this week.

"When you look at corporate earnings, which are immune to politics, you see that companies have been knocking the cover off the ball," said Douglas Cote, the chief market strategist at ING.

Despite weak economic growth in the U.S., corporations in the S&P 500 are on pace for record profits for the year. Big companies have cut operating costs dramatically the past three years. Many also get nearly half of their revenue overseas. That means they can generate higher profits even if demand for their goods and services isn't increasing as quickly.

Ablin, of Harris Private Bank, said Sunday that even a tentative agreement should energize the markets on Monday— "just for the resolution alone."

"Any deal that forestalls a technical default is going to be greeted by at least a 200-point move to the upside on the Dow," he said Sunday.

While plenty of other challenges loom ahead politically and economically, Ablin said the market already has built in enough of a negative outlook to be able to absorb those bumps.

Among those challenges: A report Friday said that the U.S. economy grew at an annual rate of only 1.3 percent from April through June. This year the economy has grown at its slowest pace since the recession ended in June 2009.

A debt deal that cuts short-term government spending significantly could further weaken the economy, experts say.

Analysts say companies won't be ready to hire and invest in new projects until some other Washington issues are resolved, like the cost of health care legislation passed last year and financial reform legislation.

Mark Luschini, chief investment strategist at Janney Montgomery Scott investment firm in Philadelphia, said Sunday that he expected a market rally once a deal is reached. But then he said attention would turn very quickly to the jobs report that will be released on Friday. Economists expect that it will show 110,000 jobs were added by employers in July, according to FactSet. That's well below the level that would indicate healthy job growth.

Analysts said if a deal is reached by Tuesday, investors will chalk up the market-rattling debt drama as another example of Washington theatrics.

If there is no deal, however, they say politicians will have done lasting damage to the nation's credibility. Over time, that could make U.S. government debt less desirable worldwide. That, in turn, could raise the cost of borrowing for the U.S. government.

Some lawmakers expressed optimism on Sunday that a deal would be reached. But investors remain frustrated at Washington for creating so much economic uncertainty.

Uri Landesman, the president of Platinum Partners, a New York hedge fund said Sunday that this crisis has been worse for the markets than any he has seen before because it is occurring when the economy is weak.

"There has been incredibly weak leadership all the way around," Landesman said.

--AP Business Writer Dave Carpenter contributed to this report from Chicago.