See prospects of default; short covering: Nick Parsons

S&P 500 has actually fallen in 7 out of the last 8 trading sessions in anticipation of the US government shutdown, says Nick Parsons, Head of Research, UK & Europe, National Australia Bank. The market is witnessing little bit of short covering, he says. Even after the shutdown, politicians on either side in the United States are not showing any spirit of conciliation, reconciliation or of negotiation and against this backdrop it will be very difficult to come to an agreement, he adds.

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According to him, this in turn raises the prospects of a formal default because there is enormous amount of bitterness and acrimony on both sides and even if the spending bill is passed, the debt ceiling problem will arise once again around October 17 or 18. He sees further downside ahead for global markets.
He says neither side feels any urgency in these negotiations after what happened in 2011 when the United States lost its AAA rating, but bond yields actually fell. This is turn has led to a situation now where there is no fear of the bond market collapsing if an agreement is not reached, he adds. Below is the verbatim transcript of Nick Parsons' interview on CNBC-TV18 Q: Given that most people did not expect US government shutdown to come to pass given the underlying fragility of the economy, it has now happened. Does this raise the probability of US defaulting on its debt or breaching that debt ceiling in the middle of October?
A: It was increasingly clear over the last few days that government would shutdown. If you look at the price action in the stock market, for 7 out of the 8 trading sessions the S&P 500 has actually fallen in anticipation of that. I think today's price action can be characterized very much as sale the mystery by the history.
It fell in anticipation of something and we are seeing a little bit of short covering. I think the markets are in danger of being exceptionally complacent here and there is more trouble brewing because if you listen to politicians on either side in the United States there is no spirit of conciliation, reconciliation or of negotiation and it is very difficult to see how they are going to come to an agreement.
To answer your question specifically about does that raise the prospects of a formal default, then yes it does, because there is enormous amount of bitterness and acrimony on both sides of the debate and even if we manage to pass this spending bill we have still got the problems of the debt ceiling that are going to rise at some point on or around 17th or 18th of October. So I think there is further downside ahead for global markets. Q: If a US debt default come to pass between now and middle of October, how do you expect markets to react to this heightened prospect of that taking place?
A: I think they are going to react negatively. Let's face it, this is no way to run a lemonade stand, let alone a country of 314 million people and the idea that the United States can lecture the rest of the world on democracy and political accountability looks somewhat laughable at the moment when they cannot even run their own government.
So I think it does raise considerable risks. Clearly the memory of 2011 is still fresh in the minds of investors when the US lost its AAA status. Its credit rating was downgraded, but bond yields actually fell. So the prospect of a downgrade itself is not as scary as it might have been in 2011.
The problem is that with the 2011 experience you can see that neither side feels that it has really got a gun to its head. Neither side feels there is any urgency in these negotiations, because they cannot say, well look if we do not reach an agreement the bond market is going to collapse on a downgrade, because last time they were downgraded the bond market did not collapse.
So for me this is just soaking up more problems rather than fewer and the outlook for the next few weeks is going to be extremely nervous indeed. Q: What kind of downside do you expect from here? Add to that the emerging markets (EM) focus. What will it mean for our currency? What will it mean for equity flows?
A: In terms of the magnitude it would not be unreasonable to think of at least a 5 percent decline in equity prices from here over the course of the next few weeks. Q: Is that US specific? Is that Europe specific or is that emerging market specific?
A: That is globally. It is triggered by the US, but nowhere uncorrelated. The rally that we have seen in EM over the course of the month of September was not dissimilar to what we saw in major markets. If major markets are going to fall on these uncertainties then it is quite reasonable to expect that EM is going to do the same.
So if we think of a fall of the order of magnitude of somewhere up to around 5 percent, then we are in a situation at the moment where that is not enough of a rout to give enough of the safe haven bid to the US dollar, but other major currencies are going to do well, but I think EM is just on the point of struggling.
Let us remember the EM rose 7 percent in September, so it has got some gains to give back. We are not talking here about panic stations, but I would have thought the next couple of weeks the nervousness is going to translate into price action to the downside for currencies and for equities.