After reacting calmly to the fiscal train wreck underway in Washington, DC last week, financial markets began to display a certain degree of discomfort through the first half of this week.
On Monday, the US Treasury's $35B four-week bill sale went very poorly, with the rate hitting its highest level since March 2008, triple the rate of the last four-week auction, as traders continue to shy away from holding short-term US paper.
Both Japan and China (the first- and second-largest foreign holders of USTs) demanded that Congress ensure the stability of their very substantial investments, while ratings agencies warned they would reconsider US sovereign ratings if there were no debt limit solution.
By Friday, the House Republican leadership looked ready to resolve the crisis and undertake serious negotiations with the White House.
The new Republican offer would set up negotiations on two tracks: the first to reopen the government and the second to craft a broader budget deal that would fund the government through 2014 and raise the debt ceiling. Reports suggested that if the president accepts the framework, the House could vote Friday on a six-week short-term debt ceiling hike.
Because of the government shutdown there was a dearth of US economic data, and the data that was reported disappointed expectations. The weekly jobless claims hit six month highs on more claims processing issues in California and as government furloughs started to impact the data, and preliminary October University of Michigan confidence fell to its lowest level since January.
Minutes of the last FOMC meeting confirmed that the "close" decision not to taper in September was largely based on concerns the debt ceiling debate could hurt the economy, and several Fed Governors and Presidents this week said the government shutdown showed they made the right call.
The September FOMC minutes were keenly dissected for any insight into the Fed's taper strategy, although there was little new to be found. The decision not to scale back QE was a close call for some members but many of those members have already said as much in their public statements. Another big focus was the importance of maintaining the distinction between QE taper and low interest rate guidance. There was some discussion of possibly linking a taper decision with expanded forward guidance, with the latter potentially including an inflation floor (no rate hikes until inflation is above 1.5%) or additional information about the Fed's rate hike plans after unemployment reached 6.5%.
With little fanfare, President Obama nominated Janet Yellen for the Fed Chairman post, making the safe and expected choice for continuity of the Bernanke legacy.
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