Bloomberg News - Central Banks Gaming Out U.S. Default as Deadline Nears

Central banks have begun making contingency plans on how they would keep financial markets working if the U.S. defaults on the world’s benchmark debt.

Policy makers discussed possible responses when they met at the International Monetary Fund’s annual meetings in Washington over the weekend, said officials who spoke on condition of anonymity because the talks were confidential. The discussions continued as policy makers headed home.

“Because in the past it’s always been sorted out is absolutely not a reason to fail to do the contingency planning,” Jon Cunliffe, who joins the Bank of England as deputy governor forfinancial stability next month, told U.K. lawmakers yesterday. “I would expect the Bank of England to be planning for it. I’d expect private-sector actors to be doing that, and in other countries as well.”

The initial response from the world’s central banks would likely echo their actions after the collapse of Lehman Brothers Holdings Inc. in 2008. Back then, policy makers pledged they would provide ample liquidity, eased the collateral they lent against and boosted dollar swap lines with each other to ensure supply of the currency.

The $12 trillion of outstanding U.S. government debt is 23 times the $517 billion Lehman owed when it filed for bankruptcy on Sept. 15, 2008.

Time Short

“The bank has at its fingertips a range of tools to ensure the system operates properly, that liquidity conditions remain normal in all sorts of eventualities,” Bank of Canada Governor Stephen Poloz told reporters in Washington on Oct. 11. He declined to talk about specifics.

Central bankers would have had a chance to discuss the threat of default when U.S. Federal Reserve Chairman Ben S. Bernanke hosted a lunch of counterparts on Oct. 12 during the IMF meetings.

Time is running short for U.S. lawmakers as they try to end a stalemate that risks pushing the nation into default if the government’s borrowing authority isn’t raised before Oct. 17. Senate Democratic and Republican leaders were working yesterday on the details of an accord that would prevent the nation from breaching the debt ceiling and end a partial government shutdown now entering its 15th day.

‘Tremendous Progress’

“We’ve made tremendous progress,” Senate Majority Leader Harry Reid, a Nevada Democrat, said yesterday as the chamber adjourned, adding that he hoped a deal could be announced as soon as today. His Republican counterpart, Senator Mitch McConnell of Kentucky, said there was “substantial progress.”

While policy makers from Japan to Saudi Arabia have expressed faith in the ability of the U.S. to pay its bills, a default would put the world in uncharted territory.

Central bankers have spent the past six years expanding their toolkit for dealing with a financial crisis that began in August 2007 when tremors in the U.S. subprime mortgage market began reverberating worldwide. That turmoil deepened with the Lehman failure and was then extended by Europe’s fiscal woes.

“You want the plumbing of the financial sector to keep working even with the main benchmark in default,” said Rob Wood, an economist at Berenberg Bank in London and a former official at the Bank of England. “You want to avoid a firesale of U.S. assets.”

Lines Extended

The Fed opened what eventually became 14 swap lines in December 2007 to provide the global financial system with dollar liquidity as the subprime mortgage crisis stirred doubts about the quality of assets on bank balance sheets around the world. They were boosted as markets froze the following year.

The swaps were closed in February 2010 and re-opened three months later amid a squeeze in dollar funding due to the euro area debt crisis. Last December, the Fed extended the lines with the Bank of Canada, Bank of England, the European Central Bank and the Swiss National Bank (SNBN) until February 2014. The swaps allow the central banks to borrow in dollars from the Fed and then auction them at home.

With less room to cut interest rates now than in 2008, when major central banks did so in unison, a U.S. default would prompt officials to first focus on pumping cash into the financial system, said Stewart Robertson, an economist at Aviva Investors Ltd in London, which has about $438 billion under management.

“There are other measures they can take, such as easing liquidity strains,” Robertson said. “They might actually find that easier than after Lehman. At that time there was really a worry about who was holding billions and trillions of toxic waste. With this, you know more what’s happening.”

‘Not Forget’

Sri Lanka unexpectedly cut its two main interest rates by 50 basis points today to protect economic growth from the risk of a U.S. default. Congress’s failure to clinch an agreement has been “very, very difficult for us to understand” and “something we will really fret about in the next few months,” central bank Governor Ajith Nivard Cabraal said in a Bloomberg Television interview today.

“Even if the U.S. were to get their act together and get past the debt ceiling, I think the fact that the global economy has been put under so much stress, is something that many policy makers would not forget,” Cabraal said. That’s going to lead to “various changes in the way central banks will perceive the safety and quality of investments,” he said.

Policy Band-aid

While they could utilize swap lines and keep accepting Treasuries as collateral, central banks would probably hold back on easing monetary policy because they would bet the U.S. would quickly end the default once markets turned volatile and recession loomed, said Wood of Berenberg Bank.

“It’s only if you think the default will be extended and politicians won’t react enough that you would engage in significant monetary policy,” he said. “Would you buy oodles more bonds if you expected lawmakers to act?”

To be sure, not even the world’s most powerful central banks have the weapons to counter the potential fallout of even a so-called technical default, finance executives say.

“It will be like putting band-aids on a gaping wound,” Deutsche Bank AG co-Chief Executive Officer Anshu Jain said at a panel discussion hosted by the Institute of International Finance in Washington on Oct. 12.

‘Irrevocable’ Aspects

Jain said the bank’s analysis of the consequences of even a “technical default” found that “there are aspects to that which are irrevocable.”

“Once you miss payment on U.S. Treasury debt, we don’t want to go into all of it but I’ll give you a little taste,” said Jain. “Things like tri-party repo, the underpinning of the collateral system, there are legal ramifications which we believe are probably incurable.”

JPMorgan Chase & Co. (JPM) CEO Jamie Dimon said at the same event that his bank has calculated it probably processes about six or seven billion dollars a week in benefits such as Social Security, food stamps and veterans benefits. “We were going to fund it, despite the fact that we weren’t being paid by the government, because those people have to eat,” Dimon said.

A default, however, would be tougher to prepare for, he said.“You don’t know the effect and the ripple effect of that through money market funds, people start drawing down revolvers, people don’t know if collateral is good,” he said. “We can’t have a debt default.”

For those reasons, global financial policy makers maintain that a default is unlikely.

“It’s unthinkable that an agreement won’t be found,” European Central Bank President Mario Draghi told reporters in Washington. Japanese Finance Minister Taro Aso told Bloomberg Television’s Sara Eisen that “there’s no other way than for the U.S. government itself and the U.S. Congress to sort it out.”

What Happens When the Money Runs Out?

Treasury Secretary Jacob J. Lew has said the U.S. government will exhaust its ability to borrow more on Oct. 17, triggering a possible default on federal obligations. Though no precedent exists, a study by the Washington-based Bipartisan Policy Center suggests that the government may attempt to pay some or all of its bills under one of two scenarios.

PUBLISHED OCT. 15, 2013

1 – Payments to providers 2 – Active military and veterans benefits

3 – Unemployment/Housing and Urban Development (HUD)/Temporary Assistance for Needy Families (TANF)

Source: Bipartisan Policy Center

GRAPHIC: DAVE MERRILL / BLOOMBERG VISUAL DATA

To contact the reporters on this story: Simon Kennedy in London at skennedy4@bloomberg.net; Jeff Black in Washington at jblack25@bloomberg.net; Jennifer Ryan in London atjryan13@bloomberg.net

BBC News - IMF chief warns a US default could spark recession

The head of the International Monetary Fund, Christine Lagarde, has warned that a US default could tip the world into recession.

Christine Lagarde warns of 'massive disruption'

In a US TV interview she said a default would result in "massive disruption the world over".

The US Treasury will start to run short of funds on Thursday if no agreement is reached for it to raise its debt limit.

Democratic and Republican leaders in the Senate held direct talks for the first time in weeks on Saturday.

But there is little sign of any breakthrough, correspondents say.

In an interview with ABC's Meet the Press Christine Lagarde said America must now raise the debt ceiling before Thursday's deadline.

"If there is that degree of disruption, that lack of certainty, that lack of trust in the US signature, it would mean massive disruption the world over and we would be at risk of tipping yet again into recession," she said.

World Bank

The president of the World Bank, Jim Yong Kim, has also expressed his concern over the situation.

He warned that the United States is just "days away from a very dangerous moment" because of the government's borrowing crisis.

Mr Kim urged US policymakers to reach a deal to raise the government's debt ceiling before Thursday's deadline.

He warned this could be a "disastrous event" for the world.

"The closer we get to the deadline the greater the impact will be for the developing world.

"Inaction could result in interest rates rising, confidence falling and growth slowing," said Mr Kim, speaking at the World Bank's annual meeting in Washington.

"If this comes to pass it could be a disastrous event for the developing world and that will in turn greatly hurt the developed economies as well," he added.

'Uneasy'

If the US does run short of cash, this could cause it to default on its debts, a development which would be likely to have a severe effect on financial markets around the world.

The BBC's Andrew Walker said that finance ministers from other countries think the US probably won't default, but they are uneasy and want the crisis resolved very soon.

Republicans and Democrats failed to come to an agreement on Saturday, but Senator Dick Durbin, a Democrat, said the aim was to reach a deal on extending the debt limit before markets reopen on Monday.

The White House rejected a deal for a short-term increase to the borrowing limit.

"It wouldn't be wise, as some suggest, to just kick the debt ceiling can down the road for a couple of months, and flirt with a first-ever intentional default right in the middle of the holiday shopping season," said President Barack Obama.

Shutdown

The US government has been in partial shutdown since Congress missed a 1 October deadline to pass a budget, with politicians being unable to agree funding for current spending.

This has resulted in hundreds of thousands of federal employees being sent home and government offices closing.

Republicans refused to approve the new budget unless President Obama agreed to delay or eliminate the funding of the healthcare reform law of 2010.

US Treasury Secretary Jack Lew has estimated that each week the government is shut down, 0.25% is shaved off economic growth, which was already expected to be a sluggish this quarter.

Debt burden

Mr Lew has also has warned that letting talks over the debt ceiling go down to the wire "could be very dangerous".

The current debt limit of $16.699 trillion was reached in May.

Since then the US Treasury has been using what are called extraordinary measures to keep paying the bills, but those measures run out on 17 October.

Every week, the Treasury also has to refinance $100bn worth of debt in the form of US government bonds known as treasuries.

The US also has to pay interest on its huge debt burden.

An inability to pay that interest, or pay back debt if required, would put the US into default.

On Saturday, Jamie Dimon, boss of the American bank JP Morgan said the possible repercussions did not bear thinking about.

"You don't want to know [what would happen]," he said.

"It would ripple through the world economy in a way that you couldn't possibly understand."

Bloomberg News - ECB Agrees on Swap Line With PBOC as Trade Increases

Nelson Ching/Bloomberg

The swap line will be valid for three years and have a maximum size of 350 billion yuan ($57 billion) when Chinese currency is provided to the ECB and 45 billion euros when money is given to the PBOC, the Frankfurt-based central bank said in an e-mailed statement today.

The European Central Bank and the People’s Bank of China agreed to establish a bilateral currency swap line, bolstering access to trade finance in the euro area and strengthening the international use of the yuan.

The swap line will be valid for three years and have a maximum size of 350 billion yuan ($57 billion) when Chinese currency is provided to the ECB and 45 billion euros ($61 billion) when money is given to the PBOC, the Frankfurt-based central bank said in an e-mailed statement yesterday. The arrangement is available to all Eurosystem counterparties via national central banks, it said.

“The swap arrangement has been established in the context of rapidly growing bilateral trade and investment between the euro area and China, as well as the need to ensure the stability of financial markets,” the ECB said. “From the perspective of the Eurosystem, the swap arrangement is intended to serve as a backstop liquidity facility and to reassure euro area banks of the continuous provision of Chinese yuan.”

PBOC Governor Zhou Xiaochuan pledged on June 28 to expand cross-border use of the yuan, also known as the renminbi, and encourage multinational companies to include the currency in their asset portfolios. China will allow direct trading between the yuan and foreign currencies and push for more convertibility without giving up control of capital flows, Zhou said.

‘Wider Flexibility’

“It’s a reflection of the increasing bilateral trade and a measure to accompany China’s push for wider flexibility in the exchange rate,” said Stefan Schneider, chief international economist at Deutsche Bank AG in Frankfurt. “China is integrating itself more and more into global financial markets and such agreements are part of that.”

China is the European Union’s second-largest trading partner after the U.S. The 28-nation bloc exported 71.4 billion euros of goods to China in the first six months of this year, with imports totaling 133.6 billion euros, according to the latest Eurostat data.

The Bank of England was the first in a race among European central banks to establish swap facilities with China, when it agreed on a line of 200 billion yuan and 20 billion pounds ($32 billion) in June. China, the world’s second-largest economy, has similar agreements with countries including Australia, Turkey, Brazil, South Korea and Malaysia.

Hong Kong has the largest swap agreement at 400 billion yuan, followed by South Korea with 360 billion yuan, with the ECB’s 350 billion yuan the third-biggest, according to PBOC data. The ECB swap line is smaller than initially anticipated. Frankfurt Main Finance, a lobby group based in Germany’s financial capital, said in July the facility may be as much as 800 billion yuan.

‘Symbolic Importance’

“London as the global center for currency trading still has the best chances for becoming the European center for trading in the renminbi,” Mark Williams, chief Asia economist at Capital Economics Ltd., said by phone from London. A swap line is “mainly of symbolic importance. It provides a backstop to the use of renminbi abroad,” he said.

Frankfurt is basing its push to become an offshore trading center for yuan on Germany’s close ties with China, the nation’s third-biggest trading partner. The two countries imported and exported goods and services valued at 144 billion euros between them last year, according to the Federal Statistics Office in Wiesbaden, Germany.

‘Significant Amount’

The swap agreement with the ECB “is for a very significant amount,” Christian Noyer, France’s representative on the ECB’s Governing Council, said in a statement. “This reflects the strong position of the euro in terms of international exchange. Euro-zone banks and French banks now have at their disposal the security they need to develop their business in renminbi over the long term.”

The Governing Council will discuss “technical modalities” and their communication in due course, the ECB said.

The yuan was the world’s eighth most-traded currency in August, up from 11th in January 2012, the Society for Worldwide Interbank Financial Telecommunications, or Swift, said in an Oct. 8 statement.

“Yuan is certainly becoming more internationalized,” Williams said. “Users of renminbi in Europe can have more reassurance that in any financial squeeze they would still be able to access renminbi liquidity.”

By Jana Randow & Maria Levitov

Bloomberg News - Yellen Pick Gives Emerging Markets Time to Dodge Taper Turmoil

Federal Reserve Vice Chairman Janet Yellen

Andrew Harrer/Bloomberg

As the Fed’s No. 2 official, Janet Yellen has articulated the case for maintaining highly accommodative monetary policy.

South Korea said it expects Yellen will “consider well” the effects on other nations of reducing U.S. bond-buying. A deputy Indonesia central-bank chief said the pick would be positive for local and global financial markets, and a top economic official in India said it means extra time to narrow current-account gaps in developing nations whose currencies suffered over the summer.

The White House’s announcement came days before a gathering of financial leaders in Washington, where the Group of 20 plans to identify market turmoil from central banks’ stimulus withdrawal as a key risk to the global system. Emerging-market stocks plunged in May when Chairman Ben S. Bernanke signaled that record easing may be pared, then rebounded when the Fed maintained stimulus last month.

“Obviously Janet Yellen will delay tapering -- she has taken a more soft position on this,” Chakravarthy Rangarajan, chairman of Indian Prime Minister Manmohan Singh’s Economic Advisory Council, said in an interview in New Delhi today, referring to the prospect of postponed cutbacks in Fed asset purchases under Yellen. The lesson of the turmoil after May “is that the emerging economies need to keep a watch on the current account deficit.”

Stocks Advance

Stocks in Asia rallied following the Yellen news, with the MSCI Asia Pacific Index gaining 0.4 percent. Indonesia’s rupiah, which had tumbled 9.4 percent over three months from May 21 and was among the worst-hit emerging-market currencies, today advanced 0.4 percent against the dollar.

U.S. President Barack Obama will announce the nomination at 3 p.m. in Washington on Oct. 9, a White House official said in an e-mailed statement. If confirmed by the Senate, Yellen, 67, would succeed Bernanke, 59, whose second four-year term ends in January.

“She has rich experience and an impressive resume as a policy maker,” Choi Hee Nam, director general of the South Korea finance ministry’s international finance bureau, said by phone from Sejong today. “I expect her to consider well the ripple effects on other countries” from policy decisions such as altering the Fed’s bond-buying program, Choi said.

‘Steady Course’

Bank Indonesia Deputy Governor Perry Warjiyo said in a mobile-phone message today that tapering of U.S. stimulus may not come into effect immediately with Yellen’s appointment. Philippine Finance Secretary Cesar Purisima said in a phone message that Yellen’s nomination signals stability, policy continuity and a “steady course for the Fed.”

China’s central bank and Ministry of Foreign Affairs didn’t immediately respond to requests for comment. Li Daokui, a former People’s Bank of China academic adviser, said in an interview that Yellen’s appointment means there will be a “prolonged period of appreciation” for the yuan as additional “hot money” flows into China. That deepens a policy dilemma over whether to lower interest rates to reduce the attraction for inflows, or to gear policy more toward fighting inflation, Li said.

Cao Yongfu, a researcher who follows U.S. economic policy for the government-run Chinese Academy of Social Sciences, said Yellen’s nomination will help sooth China’s short-term concerns that an immediate tapering of Fed bond-buying would cause volatility in capital flows.

Currency Impact

Even so, prolonged stimulus under Yellen may result in dollar depreciation and undermine the value of China’s foreign exchange reserves, Cao said. “Yellen’s big challenge will be to shift Fed policies back to normal from an ultra-loose stance -- you can’t always keep your foot on the gas.”

Chinese analysts weren’t the only ones seeing potential for a weaker dollar as a result of Yellen’s ascendance. Koichi Hamada, an adviser to Japanese Prime Minister Shinzo Abe, said Yellen is “more likely to seek a way to make an economic recovery certain by keeping policy accommodative.” If prospects of an exit weaken, that may put pressure on the yen to rise, risking harm to Japan and boosting the need for the Bank of Japan to act, said Hamada, who doesn’t speak for the government.

At the same time, Hamada said he would “very much welcome” Yellen’s appointment. “She has long experience in central bank policy and she understands the role of monetary policy in the macro economy. She is the most appropriate person to lead the Fed.”

Summers Exit

Yellen won the nomination after former Treasury secretary and White House economic adviserLawrence Summers withdrew from consideration when Democrats on the Senate Banking Committee expressed opposition to his candidacy.

As the Fed’s No. 2 official, she has articulated the case for maintaining highly accommodative monetary policy. In a series of 2012 speeches, she outlined why rates could remain near zero into late 2015, and in a 2011 speech she justified the Fed’s first two rounds of large-scale asset purchases with an estimate that the programs would create 3 million jobs.

Yellen isn’t among the Fed policy makers who have pressed this year to pare back asset purchases, a group that includes Esther George, president of the Federal Reserve Bank of Kansas City, Jeffrey Lacker of Richmond, Richard Fisher of Dallas and Charles Plosser of Philadelphia.

“I assume Yellen’s nomination means QE for longer and the exit of QE is likely to be gentle,” said Dong Tao, head of Asia economics excluding Japan at Credit Suisse Group AG in Hong Kong. “That would be good news for China,” which is having difficulty maintaining growth momentum just as the “tides of global money printing” may start to turn, Tao said.

Investor View

A Bloomberg Global Poll last month of investors, analysts and traders, conducted before Summers’s withdrawal, found 47 percent saying Yellen would preside over the same policy as Bernanke, with 17 percent saying it would be looser and 8 percent seeing tighter conditions. Thirty-five percent said Summers would provide less stimulus than Bernanke.

Yellen has been vice chairman of the Fed in Washington since 2010, helping to craft bond-buying and communication policies. As president of the Federal Reserve Bank of San Franciscoin the six previous years, she monitored Asia and oversaw banks with foreign exposure, including Wells Fargo & Co.

She also deepened her institution’s ties to Asia, starting a biennial conference on Asia economic policy in 2009 that attracted central bank officials from China, South Korea, the Philippines, Taiwan and Singapore, according to a list of attendees on the bank’s website.

Asia Links

Yellen oversaw many of the biggest Asian banks doing business in the U.S., hosted Asian central bankers and financial regulators for get-togethers and traveled often to the region, saidDavid Loevinger, former U.S. Treasury Department senior coordinator for China affairs.

She has a “deep understanding of Asian economies, banks and business practices,” said Loevinger, now an emerging-markets analyst at TCW Group Inc. in Los Angeles. “She was less prone to lecturing than other U.S. government officials. Asians appreciated that.”

The concern of emerging markets is that when the Fed does begin tapering its bond buying, it could hurt them by sparking an exodus of cash and higher borrowing costs. Brazil, Turkey,South Africa, India and Indonesia are the most vulnerable, Goldman Sachs Group Inc. strategists said in a Sept. 5 report.

By contrast, the International Monetary Fund said Oct. 7 that Canada, South Korea and Australia are among the countries best placed to weather any global market volatility from the withdrawal of U.S. monetary stimulus. The IMF and World Bank hold annual meetings this week in Washington, where G-20 finance ministers and central bankers will also gather.

International Era

Even if it doesn’t serve as central bank to the world, the Fed is still entering a fresh era in which international events will increasingly shape its decisions, according to Barry Eichengreen, a professor at the University of California at Berkeley, where Yellen taught.

In a July paper, he said U.S. unemployment and inflation will be affected as globalization forces the U.S. to be more open to trade and financial transactions, emerging markets eat into its share of the world economy and the dollar’s role as the sole reserve currency is eventually eroded.

“Progressively the Fed is going to have to be more outward looking,” Eichengreen said in an August interview.

--Kevin Hamlin, with assistance from Unni Krishnan in New Delhi, Cynthia Kim in Seoul, Sharon Chen in Singapore, Novrida Manurung in Jakarta, Zhou Xin in Beijing, Paul Panckhurst in Hong Kong, Toru Fujioka in Tokyo, Simon Kennedy in London and Clarissa Batino in Manila. Editors: Scott Lanman, Rina Chandran

BBC News - US releases $100 banknote with new security features

The US Federal Reserve has issued a new hi-tech $100 banknote comprising several new security features.Technology correspondent Mark Gregory takes a closer look at the new bill

It includes a blue 3D security ribbon and a bell and inkwell logo that authorities say are particularly difficult to replicate.

These combine with traditional security features, such as a portrait watermark and an embedded security thread that glows pink under ultraviolet light.

The 2010 design was delayed because of "unexpected production challenges".

The 3D security ribbon - which is woven into the note, not printed on it - features images of 100s that change into bells and move upwards or sideways depending on how you tilt the paper.

Referring to the embedded security thread Chadwick Wasilenkoff, chief executive of security paper company Fortress Paper, told the BBC: "It's not a small incremental step up for security, it's a giant leap."

Tilting also reveals a green bell within a copper-coloured inkwell to the right of the blue ribbon.

In addition, the 100 number in the bottom right-hand corner shifts from copper to green.

The redesigned banknote, which features a portrait of US founding father and scientist Benjamin Franklin, also includes raised "intaglio" printing that gives the notes a distinctive feel, and microprinted words that are difficult to read without magnification.

Forgeries

Over a decade of research and development has gone into the new note, the Fed said, in a joint project with the US Secret Service and the Department of the Treasury.

Advances in design software and high-resolution copying and printing have made it easier for counterfeiters to print fake money and harder for retailers to spot the forgeries.

US authorities say that $100 bill is the most counterfeited of all US banknotes, but accurate figures for the total value of counterfeit cash in circulation are hard to come by.

The US Secret Service estimates that counterfeit bills account for less than 0.01% of the $1.1 trillion (£683bn) of US money in circulation.

It says about $80.7m of counterfeit currency changed hands domestically in 2012, and about $14.5m abroad.

The authorities seized $9.7m in counterfeit cash before it could make it in to the US money supply, and seized $56.8m abroad in 2012.

Bruce Schneier, security expert at BT, told the BBC: "Bills have to be easy to produce cheaply and in large quantities by the government, yet hard to reproduce in small quantities by counterfeiters.

"Making something that costs less than a dollar to produce and over $100 to reproduce is a very difficult problem."

By Matthew Wall and Tom Espiner

Reuters News - U.S. shutdown seen dragging on as debt ceiling fight nears

. Empty tables and chairs are seen outside the main headquarters of FEMA, which is partially closed, during day three of the U.S. government shutdown in Washington October 3, 2013.

Credit: Reuters/Gary Cameron

By Mark Felsenthal and Richard Cowan

(Reuters) - The shutdown of the U.S. government appeared likely to drag on for another week and possibly longer as lawmakers consumed day three of the shutdown with a stalling game and there was no end in sight until the next crisis hits Washington around October 17.

Bowing to the reality that the impasse requires him to remain in Washington, President Barack Obama canceled plans to attend summits inIndonesia and Brunei next week. Earlier this week, he canceled visits to Malaysia and the Philippines because of the shutdown.

October 17 is the date Congress must raise the nation's borrowing authority or risk default, and members of Congress now expect it to be the flashpoint for a larger clash over the U.S. budget as well as PresidentBarack Obama's healthcare law.

The situation gives "every appearance of getting dangerously close to the conversation on the debt ceiling," said Nancy Pelosi, the Democratic minority leader of the House of Representatives.

In fact, she said, "We're in the conversation on the debt ceiling."

At the same time, hopes that the debt ceiling fight could be resolved without a catastrophe were raised by reports in The New York Times and Washington Post that House Speaker John Boehner told other lawmakers he would work to avoid default, even if it meant relying on the votes of Democrats, as he did in August 2011.

A spokesman for Boehner would neither confirm nor deny the reports, restating previous public statements by the speaker that "the United States will not default on its debt."

Senator Charles Schumer, the second-ranking Senate Democrat, reacting to the reports, said, "This could be the beginnings of a significant breakthrough."

The New York senator added, "Even coming close to the edge of default is very dangerous," as he urged quick passage of legislation to raise the $16.7 trillion cap on borrowing.

There was little action along with the talk on Thursday. The Republican-controlled House continued what has become a long process of voting to fund publicly popular federal agencies - like the Veterans Administration, the National Park Service and the National Institutes of Health - that are now partially closed.

Republicans know that neither the Democratic-controlled Senate nor Obama will go along with such an approach, but it allows them to accuse Democrats of working against the interests of veterans, national parks and cancer patients.

House Republicans on Thursday began lining up 11 more bills to fund targeted programs. They are to fund nutrition programs for low-income women and their children, a program to secure nuclear weapons and non-proliferation, food and drug safety, intelligence-gathering, border patrols, American Indian and Alaska Native health and education programs, weather monitoring, Head Start school programs for the poor and other aid for schools that rely heavily on federal assistance.

Disaster assistance also is slated for temporary renewal under the House measures, as well as a bill to provide retroactive pay to federal workers during the government shutdown.

"We're trying to see if we can get the Senate and the president to start talking to us, on anything. They're just not talking to us," said Republican Representative Mario Diaz-Balart of Florida, explaining the tactic.

The bills are likely to be debated on the House floor over coming days, not all at once. Democrats have rejected the piecemeal approach and Obama has said he will veto the measures.

'STOP THIS FARCE'

In a speech at a Maryland construction company on Thursday, Obama challenged Republicans to "stop this farce" by allowing a straight vote on a spending bill. He reiterated he will not negotiate on the spending bill or the debt ceiling.

Obama said there were enough Republicans willing to pass a spending bill immediately if House Speaker John Boehner would allow a vote on a bill without partisan conditions attached, a so-called clean vote. But Obama said the speaker was refusing to do so because "he doesn't want to anger the extremists in his party."

"My simple message today is 'Call a vote,'" Obama said. "Take a vote. Stop this farce, and end this shutdown right now."

Work in Congress was interrupted on Thursday afternoon when the U.S. Capitol was locked down briefly due to gunshots fired outside the building. One female suspect was shot dead after a brief car chase across downtown Washington. Police said it appeared to be an isolated incident.

The security alert halted work in both the House and the Senate and briefly diverted attention from the shutdown that took effect at midnight on Monday, leaving nearly a million federal workers sidelined without pay and many others in the private sector suffering from the knock-on effect.

The Capitol Police who responded to the incident are working without pay due to the shutdown - they are deemed essential and so remain on the job, but their pay is frozen.

ECONOMIC WARNINGS

In his speech earlier, Obama warned that as painful as the government shutdown was, a default caused by a failure to raise the debt limit would be dramatically worse for the economy.

Alhough some moderate Republicans have begun to question their party's strategy, Boehner so far has kept them largely united with the small bills to reopen national parks, restore health research and other parts of the government most visibly affected by the shutdown.

The Tea Party Express, one of the anti-tax groups in the conservative Tea Party that has led the fight against Obamacare, sent an email to supporters on Wednesday evening saying that as many as 12 Republicans had indicated they were willing to "give up on the fight" and join Democrats in voting for a funding bill without conditions.

"We need your immediate support to put pressure on the weak Republicans to pass a sensible solution that allows America to avoid the Obamacare train-wreck, while fully funding the federal government," the group said in its email.

The U.S. Treasury warned on Thursday about the "catastrophic" impact of a debt default, saying a failure to pay the nation's bills could punish American families and businesses with a worse recession than the 2007-2009 downturn.

Major stock markets fell on Thursday, while the dollar dropped to an eight-month low over concern the budget standoff would merge with the coming fight over raising the U.S. borrowing limit.

The U.S. Labor Department on Thursday said the government's September employment report, the most widely watched economic data both on Wall Street and Main Street, would not be released as scheduled on Friday due to the shutdown.

Despite the shutdown, Republicans have failed to derail Obama's controversial healthcare law, which passed a milestone on Tuesday when it began signing up uninsured Americans for subsidized health coverage.

Obama blamed the shutdown on Republicans' "obsession" with reversing healthcare reforms passed in the Affordable Care Act, but noted they had been passed by the House of Representatives and the Senate and been deemed constitutional by the Supreme Court.

"Last November, the voters rejected the presidential candidate that ran on a platform to repeal it," he said on Thursday. "So the Affordable Care Act has gone through every single democratic process, all three branches of government. It's the law of the land. It's here to stay."

(Reporting by Richard Cowan, Steve Holland, Jeff Mason, Susan Heavey, Jessica Wohl; Writing by Fred Barbash and Claudia Parsons; Editing by David Storey, Tim Dobbyn and Peter Cooney)

Bloomberg News - Debt Ceiling Wall of Worry Another Reason for Investing

Traders work on the floor of the New York Stock Exchange (NYSE) in New York on Sept. 30, 2013.

The U.S. congressional standoff that shut down the government for the first time in 17 years is a buying opportunity for stock investors, if history is any guide.

The Standard & Poor’s 500 Index (SPX) has risen 11 percent on average in the 12 months following a government shutdown, according to data compiled by Bloomberg on instances since 1976. That compares with an average return of 9 percent over 12 months. In all the cases, the U.S. equity benchmark was higher by the end of the next two years.

While the S&P 500 has fallen seven of the past eight days on concern the political deadlock over the U.S. budget and debt limit will hurt the economy, investors at Raymond James & Associates and PNC Wealth Management say equities will recover as profits rise. Analysts’ forecasts show earnings will increase at the fastest pace in two years during the fourth quarter. More than 300 companies in the S&P 500 are scheduled to report results this month, according to data compiled by Bloomberg.

“I’m a buyer on weakness,” Jeff Saut, the St. Petersburg, Florida-based chief investment strategist at Raymond James, said in a phone interview. He helps oversee about $400 billion. “Once it’s in the rearview mirror along with the debt ceiling, the market will start to focus again on the improving economic numbers and improving earnings.”

The S&P 500 rose 0.8 percent to 1,695.10 at 12:03 p.m. in New York, snapping a two-day drop.

Partially Closed

The U.S. government will be partially closed today with Congress deadlocked over whether to tie any changes to the 2010 health-care bill to an extension of government funding. Even if the budget fight is resolved, lawmakers would immediately move to the next fiscal dispute over raising the $16.7 trillion debt ceiling.

The S&P 500 slumped 0.6 percent to 1,681.55 yesterday, closing at a three-week low. The U.S. equity benchmark is still up 18 percent this year, on track for the biggest annual increase since 2009. Treasury 10-year note yields fell one basis point to 2.61 percent yesterday, trading at an almost seven-week low, and the dollar weakened against the majority of its most-traded peers.

There have been 17 government shutdowns since 1976, with five of them occurring within three months of each other, according to data compiled by Bloomberg.

Debt Ceiling

The last time there was speculation about a U.S. government shutdown was in August 2011, when the S&P 500 fell more than 11 percent in three days. Stocks tumbled during the stalemate between President Barack Obama and Congress over whether to raise the debt ceiling and S&P stripped the U.S. of its AAA credit rating that month.

The losses were later reversed, as the Federal Reservepledged to hold the benchmark interest rate near zero and maintain bond purchases to support the economy. The S&P 500 gained 25 percent in the 12 months through August 2012.

“If you go back to the 1990s and the last time we had a government shutdown, that was actually good for the stock market,” said Martin Leclerc, founder of Barrack Yard Advisors LLC, in a phone interview fromBryn Mawr, Pennsylvania. His firm oversees $230 million. “It seems the market has climbed every wall of worry and every risk that’s out there, the market has seemed to surpass.”

Stock Swings

In the last government shutdown that started in December 1995, the S&P 500 rallied 21 percent in the following year, according to data compiled by Bloomberg. The U.S. equity benchmark was up 36 percent in the 12 months after a one-day closure in 1982. That was the biggest advance of the 12 instances.

Stock swings will widen during the shutdown, according to Kristina Hooper, a U.S. investment strategist at Allianz Global Investors in New York. The firm oversees $409 billion. The S&P 500 has declined an average of 0.59 percent during government shutdowns since 1976, according to data compiled by Bloomberg.

“We’ll definitely see more volatility if there is a shutdown, because the majority of the market wasn’t anticipating it as late as last week,” Hooper said in a telephone interview yesterday. “The longer-term picture is positive. We’ll likely work through this relatively quickly.”

The Chicago Board Options Exchange Volatility Index (VIX) jumped 7.4 percent to 16.60 yesterday, the highest level in a month. It is still 18 percent below its average since 1990.

Fair Value

Stocks need to fall further before they become bargains, according to Kevin Caron, a Florham Park, New Jersey-based market strategist at Stifel Nicolaus & Co., which oversees about $150 billion. The S&P 500’s valuation slid to 16.1 times reported operating earnings yesterday, from a three-year high of 16.5 on Sept. 18. The benchmark’s multiple has increased 14 percent this year.

“We haven’t seen a significant correction yet,” Caron said in a phone interview. “We’re right around what we would consider to be fair value for the market.”

A shutdown of the U.S. government may reduce fourth-quarter economic growth as federal workers from park rangers to telephone receptionists are furloughed, according to Moody’s Analytics Inc. Mark Zandi, chief economist at the firm, has estimated that a three-to-four week shutdown would cut growth by 1.4 percentage points. He projects a 2.5 percent annualized pace of fourth-quarter growth without a shutdown.

Earnings Growth

E. William Stone, chief investment strategist at PNC Wealth in Philadelphia, said the gridlock in Congress isn’t likely to weaken the overall economy. Earnings for S&P 500 companies will increase 9.1 percent in the fourth quarter, the biggest expansion since the three months ending September 2011, according to more than 11,000 analyst estimates compiled by Bloomberg.

Profits have been climbing for the past four years and analysts forecast growth will continue in 2014 and 2015, when they rise more than 10 percent. For the full S&P 500, earnings expanded 1.8 percent last quarter, projections compiled by Bloomberg show. Alcoa Inc. (AA), Yum! Brands Inc. (YUM) and Safeway Inc. (SWY) are among the 316 companies in the S&P 500 scheduled to report in October.

“It certainly makes sense in our mind to take advantage of these kinds of selloffs,” Stone said by phone yesterday. The firm manages about $119 billion. “At the end of the day you go back and say, does this whole fight really harm the long-term market or the underlying economic picture? And I don’t think it will really have any true impact there.”

To contact the reporters on this story: Nick Taborek in New York at ntaborek@bloomberg.net; Whitney Kisling in New York at wkisling@bloomberg.net