LONDON – If ever there was a pivotal moment for financial markets, this could be it: The United States defaults and investors face the great unknown, or it doesn't and one of 2011's key risks is removed.
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Not that the coming week does not hold other events of note. There are central bank rate decisions and a raft of significant economic reports, for example. The euro zone crisis is also rumbling on.
But far and away the most important issue for investors is Tuesday's deadline for Washington to raise its $14.3 trillion debt limit. To investors' dismay, approval is being held up by a bitter partisan squabble between Democrats and Republicans.
Without agreement the vaunted ``triple A''-rated U.S. economy could default by not paying all its bills, at least temporarily.
After weeks of failed negotiations, U.S. lawmakers were close to a last-gasp $3 trillion deal on Sunday to raise the U.S. borrowing limit and assure financial markets that the United States will avoid a potentially catastrophic default.
For markets, however, seeing is believing and investors are not likely to rest easy until a deal is firmly in place.
The government has said Aug. 2 is the deadline to raise the debt ceiling but this date is not necessarily inviolate. The U.S. Treasury could decide it was a priority to keep paying its debt obligations, avoiding any short-term default.
In theory, however, lack of agreement could prompt turmoil on financial markets, with investors selling U.S. debt, dumping other dollar-denominated assets, running away from global risk assets and scrambling into already overcrowded safe havens.
Gold , for example, has risen close to 10 percent in July alone, hitting a series of all-time nominal highs as investors have fled the twin U.S. and euro zone debt crises. Similarly, the Swiss franc has soared against both the dollar and the euro in the month.
``We are suggesting that there could well be some more volatility. But we are not inclined to believe that volatility will last long,'' said Kevin Gardiner, managing director of research and economics at BarclaysWealth.
He said there might even be some opportunities created if assets such as U.S. equities react negatively, making them cheaper.
A default, nonetheless, would raise huge questions about the supposed sanctity of the world's largest economy, triggering immense stress on U.S. money market funds, tempting banks to stop lending to each other as in the Lehman crisis, and potentially tipping the country back into recession.
If, on the other hand, negotiators in Washington succeed in raising the debt limit, an argument can be made that a relief rally of riskier assets would be in order.