Investors are monitoring the fast approaching debt ceiling limit on federal spending. The U.S government could reach its debt limit by mid-October. The U.S Federal Reserve expects to reduce its monthly bond-buying program, but the risk of the U.S defaulting on its debt raises doubts of tapering. Gold prices have ballooned as investors placed funds into safe haven assets to protect their investments from market uncertainty. Investors may consider investing in undervalued gold mining producers as the gold market recovers.
Debt ceiling concerns
The U.S Treasury Department said it would reach its $16.7 trillion debt limit by mid-October. U.S Treasury Secretary Jacob Lew advised Capitol Hill to raise the borrowing limit before the possibility of default. If Congress does not raise the debt ceiling, investors would “become unwilling to loan the United States money, the United States could face an immediate cash shortfall,” Lew said in a letter to House Speaker John Boehner. “Indeed, such a scenario could undermine financial markets and result in significant disruptions to our economy.”
The Obama administration expects the U.S to have about $50 billion in cash on hand by mid-October with no capability of borrowing more funds. The administration told Congress it would not negotiate on raising the debt ceiling, while Congress demands spending cuts before it agrees to raise the $16.7 trillion limit. Internal political tension between Democrats and Republicans could trigger a sell-off in equities. This is not the first time the debt ceiling debate set off uncertainty in the financial markets.
In April 2011, former Treasury Secretary Timothy Geithner warned that the U.S would hit its debt limit by May 16, 2011. Congress agreed to raise the debt ceiling in early August 2011. Although Congress addressed the issue, Standard & Poor’s downgraded the country’s AAA credit rating for the first time. This event disrupted global markets. The U.S dollar faced currency debasement, the S&P 500 plummeted, and gold futures and gold-backed ETFs reached new highs for the year. If Congress fails to raise the federal debt ceiling this time around, market reactions could reflect results from two years ago, where investors pulled away from equities and jumped into physical and paper gold.
Source: CNNMoney — The red box depicts the markets reaction to the U.S debt limit debate from May to August 2011. The dark blue line represents SPDR Gold (NYSEMKT:GLD) Shares. The yellow line represents the S&P 500.
The Fed’s tough decision
The U.S central bank looks to reduce its monthly purchases of $85 billion in Treasuries and mortgage-backed securities. The market believes the Fed could start tapering following the Federal Open Market Committee (FOMC) meeting this month. The Fed’s decision to taper its bond buying is dependent on the growth of the U.S economy and labor market. The country’s GDP growth rose to 2.5% in the second quarter, beating estimates of 1.7% growth, but conflicts in the Middle East and debates over the debt limit could lag growth in the coming months. Hedge funds and speculative investors have reacted cautiously, transferring their funds from equity markets into safe haven assets such as gold futures and gold-backed ETFs to hedge against uncertainty.