As the possibility of a bigger deficit-cutting deal fades away, the status quo will be upheld -- and nobody should be surprised
The congressional "supercommittee" is looking pretty lame. Its failure approaches as the group of twelve Republicans and Democrats tasked with reducing the deficit can't come to an agreement. The divide that they cannot overcome stems from mostly what you would expect: the right wants bigger spending and entitlement cuts, while the left wants to raise taxes. Neither side will budge, so the so-called "trigger" will be pulled instead, which will automatically cut $1.2 trillion from the federal budget over the next 10 years. Will the market react with a nod, a frown, or a shrug?
The Market Shouldn't Be Surprised
In fact, the market should be unfazed: it should have expected precisely this outcome. The supercommittee was essentially designed to fail. What we have come to know about Congress is that it waits until the absolute last second to act when it absolutely must. In this case, however, it wasn't under any real pressure to act. Even its failure to compromise would result in an action that neither party liked, but each would likely see as better than making political concessions.
Think about the political ramifications of an agreement being reached. For that to occur, either Republicans or Democrats (or both) would need to compromise their principles. And for what? Even if they don't agree to a compromise, cuts will happen anyway. As you may recall, even when the nation was on the verge of a default due to hitting the debt limit in August, Congress barely managed to avoid catastrophe. Can anyone reasonably expect a broad, aggressive compromise when politicians are under so little pressure?
The Status Quo Upheld
By now, the market should understand this. It should have priced in a supercomittee failure. But from the market's perspective, that failure might not look all that different from success: either way, little more than $1.2 trillion in deficit cuts would have occurred. Even if a compromise was reached, almost no one expected cuts to much exceed $1.5 trillion. So success and failure should have looked approximately the same from the market's standpoint anyway.
On some level, the market might even be relieved. After all, Congress could have done something stupid instead. If the supercommitte had felt really aggressive about deficit reduction, it could have cut too deeply too quickly and endangered the already weak economy. Slicing a mere $1.2 trillion off of the budget over 10 years starting in 2013 isn't likely to reverse whatever modest recovery might be taking place in the U.S.
And really, at this time, the market doesn't appear to be calling for anything much more aggressive. Treasury yields remain ridiculously low. At the end of last week, 10-year Treasury yields dipped below 2%. At this time last year, they were near 3%. A decade ago, they were around 5%. Despite the U.S.'s unsustainable debt path, investors remain very, very comfortable with Treasuries. Can you really blame them? Compared to Europe, the U.S. looks like a pretty great place to park your money.