One of the great mysteries, in political circles, about this month's extended debt-ceiling hostage negotiation is why financial markets aren't paying more attention. The stock market has risen, not fallen, over the last week as debt-ceiling talks have deteriorated, and while short-term bond yields have risen, longer-term yields have mostly stayed put. And as I called around to various Wall Street trading desks in the last week, I learned that many traders, too, are taking a wait-and-see approach to the talks.
You'd expect (and, if you're a reporter for the AP, you'd hope for) traders to be making big bets right now. After all, flux and instability breed profit opportunities. But if markets are to be believed, it simply isn't happening. So why do traders seem to be sitting this one out?
I had a conversation with a Wall Street trader yesterday — a guy who specializes in energy trading, an area of the market that often responds aggressively to major geopolitical events. This was his explanation for why trading the debt-ceiling fight is not something he's keen on doing (emphasis added):
I don't like the trade. In the highly unlikely scenario Boehner won't hold a vote on the Senate bill that gets passed, the next day in the markets will be a mess. The dollar will sink, and a massive world economic contraction will be priced into commodities, sending them lower. The exception to this, of course, will be gold. "Short everything, long gold" is a trade I would like if I believed they wouldn't raise the debt ceiling, but I believe they will.
Basically, this trader sees no profit in the most likely debt-ceiling scenario, and no predictive ability in the unlikely, terrible scenario. The market hasn't yet priced in a default, so there are no obvious buy-low-sell-high opportunities to jump on now, before a debt-limit extension is passed. And if a debt-limit extension isn't passed in time to avoid a default, the markets will be such a circus that there may well be no good trading strategies, other than trying to pick up some obviously distressed assets and some market freak-out commodities like gold.
Usually, traders love volatility. But this kind of volatility — a 99 percent chance that the bomb will be defused before it blows, and a one percent chance that House Republicans blow the markets to smithereens — isn't the kind you can trade on. It's one situation in which traders have no informational advantage over ordinary Joes watching news headlines from the Capitol. (In fact, it's the rare situation in which John Boehner could probably predict market moves more accurately than a hedge-fund manager.) And many of these traders lost money on both the 2011 budget fight and the fiscal cliff scare of last year, making them even more reluctant to jump into the pool.
So while you may see markets responding to each turn in the debt-ceiling negotiations in the coming days, keep in mind that for the most part, these reactions represent the actions of a few speculators in fairly illiquid markets like credit-default swaps on U.S. debt and short-term plays like one-month Treasury bonds. Most traders, especially the smart ones, are sitting this one out.