Nervous Financial Markets Get More Bad News

With the stalemate in Washington over increasing the debt limit showing no signs of resolution, nervous financial markets absorbed some more bad news today.

The U.S. Commerce Department reported the nation's economy grew at an anemic 1.3 percent rate in the second quarter of the year. That, on the heels of first quarter growth that barely moved the needle.

For the first six months of the year, the world's largest economy grew at the slowest rate since the recession officially ended two years ago. Consumer spending rose only 0.1 percent in the second quarter while government spending fell for the third straight quarter.

The current standoff in Washington is about how much more government spending should decline. The government's current debt limit will be exceeded August 2 unless Congress raises it, a prospect that appears less likely with each passing hour.

President Obama and fellow Democrats have agreed to projected spending cuts over 10 years without increasing tax revenues, but fiscally conservative members of the House, many of them Republican freshmen elected with Tea Party support, are demanding systemic changes that will significantly cut U.S. spending and reduce the level of debt.

Resilient markets, for now

In spite of today's bad news about economic growth and growing pessimism that a deal limit deal will be reached, Wall Street showed remarkable resiliency in today's trading. The S&P 500 was off just 0.35 percent in late morning trading.

While many media headlines confuse the passing of the debt ceiling deadline with default on U.S. debt, the head of Standard & Poors told Congress this week that a U.S. Government default would be "highly unlikely."

However, the result of cutting off the flow of new credit would likely be chaotic for the markets next week, many analysts believe. Regardless of what happens, some ratings agencies are likely to downgrade U.S. bonds from their AAA rating to AA.

When that happens, the government will have to offer a higher interest rate to entice buyers. While that's good for people who invest in bonds, it makes stocks look like a worse investment in comparison. That could result in some investors selling stocks and buying bonds.

Somewhat lost in the rancorous debate is the fact that when the U.S. must pay a higher rate of interest to sell its bonds, the taxpayer loses. Ironically, it will also add to U.S. debt.