A U.S. Default Is Unlikely, But So Is An Oil Rally

This week, as the deadline for reaching an agreement on raising the US debt limit approached, the ratings agency Fitch announced that they were placing the AAA debt rating of the United States government on "negative watch". If you are new to trading and investing, and particularly if you live outside of the US, that news might surprise you. I mean why would any country, least of all the one whose currency and debt form the basis of the global financial system, put its credit rating at risk periodically by squabbling about partisan politics?

The ostensible treason makes perfect sense. Someone, at some point, has to be held accountable for government spending, and forcing Congress and the President to speak about it occasionally doesn't seem like a bad thing. However, having a debt limit that must be renewed hasn't exactly limited spending since it was introduced in 1917, and the US now owes a mind-boggling $31.8 trillion. The problem is that the debt ceiling negotiations have evolved into a kind of theater of the absurd with everyone playing roles, a lot of melodramatic posturing, and a tortured path to an inevitable conclusion.

We know all this because we have been here before, and more than once. In fact, it is a regular occurrence. So, why does it continue?

The answer is because, as crazy as it may seem, history indicates that the arguing and posturing will benefit both sides politically, and that is seen by them as more important than any risk to financial stability and economic well-being. The "negotiations" around doing what must be done and raising the debt ceiling allow for the leaders of the groups involved to play to their respective bases. House Speaker Kevin McCarthy can paint himself as a brave warrior against the evils of big government, while President Biden in turn casts himself as the heroic defender of programs that protect the weakest and most vulnerable in our society. Then, when they do what they have always done and arrive at a deal in the hours before the country officially runs out of money, they can both claim to be pragmatists, who made great concessions to save America!

Little wonder, then, that at times when this stupidity has played out in the past, polls have shown that both toenail fungus and cockroaches are more popular in America than politicians!

For traders and investors, of course, whether in the energy sector or elsewhere, the most important thing here is what it means for markets.

As mentioned, based on what has gone before, the whole thing is completely predictable, which might lead you to think that markets would completely ignore it. However, that typically isn't the case. Each time it happens, markets wobble as the deadline approaches. That may be because the consequences of a default are so damaging that even a remote chance of it occurring demands attention, or it may just be one of those self-fulfilling things, where markets drop because people think they will, and position accordingly. Whatever the reason, though, a drop in stocks and probably crude as the "tension" mounts next week is to be expected.

As you might have guessed, though, that will be more of a buying opportunity than anything. A really strong rally when the last-minute agreement is reached is unlikely given that it is so predictable, but logically, the whole saga is neutral at best. Therefore, markets should quickly gain back any losses that come next week when Biden and McCarthy switch from pointing fingers at each other to claiming credit for avoiding the chaos that they created.

So, I will be trimming a few stock positions and trading crude with a short bias for most of next week even though I am completely confident that there will be no default and a deal will be reached, then reversing later in the week. That may seem absurd and even a bit cynical, but it is a strategy based on something equally absurd and most definitely cynical, American partisan politics, so it is at least fitting!