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What is going on in Washington is more of a political charade than real budget negotiations; albeit, it is a distraction from the real structural problems created from a two decade period of credit-fuelled surges in consumption. That being said, with financial markets taking a very immediate focus on the outlook of the US economy, investors are looking past this political uncertainty and for a deal to arise because they know, that inevitably, this will be resolved. That is why, despite equities only falling off marginally, the financial markets have underreacted to the developments of a government shutdown.

A lot of fear and focus is going into what will happen if the US were to actually default on its debt, but investors are seeing past this commentary because as of this point it is far too premature. The Obama Administration, through Jack Lew and the US Treasury, has done a good job fear mongering investors of the devastating effects of US default. It is also fair to say that the financial media has played a role in perpetrating this message. This, however, is only a bargaining chip at the Obama Administration’s disposal to lead voters to associate blame for this whole debacle on the Republicans and their members in Congress. And while they very well might be able to play this game of politics with the general public, it is evident over the last week that investors are yet to react.

Equities markets slipped at the beginning of the week, which was prompted by the government shutdown. This reflects some 800,000 government employees that were furloughed or temporarily laid off because their respective government agencies are not in operations. IHS Global Insight, a consulting firm, estimates the cost to be 300 million dollars a week in lost productivity to the US economy. Other analysts calculate it to shaving a tenth of a percentage point off Q4 GDP growth for every week that the government is shutdown. Obviously, in the near term, that number is of little significance, but it could very well have an impact depending on how long this shutdown is sustained.

What this means, though, is that US economy will suffer in the fourth quarter because of the brutality of their government, and that is the single greatest consequence of this government shutdown. Any market reaction to a US default will be short lived, because at this point their Treasury will not default. The US Treasury sees annual revenues between 16 and 20 percent of GDP, and interest payments on their debt amount to about 2.5 percent of their GDP annually. In the extreme scenarios where Congress fails to implement measures to raise the debt ceiling, the Treasury, for a short period of time, would still be able to make interest payments to their creditors.

The problem with this debate goes beyond the logistics of whether or not the US will satisfy debt payments; moreover, it should be focused on how the biggest impediment to the US economic recovery has been the US Government. It is inevitable we are entering a transition of deleveraging as a result of how much debt has been incurred by the world’s economic superpowers. And with that deleveraging means moderation and repression both individually and from the provisions of government. What it should not mean is halt to economic activity when governments lack the ability to show leadership and implement constructive policy.

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The markets reacted swiftly to the news of the Federal Reserve’s FOMC’s decision to not taper their asset purchases at their September meeting. The press conference following the policy announcement expanded on this to give the impression that the US Fed lacks confidence in the economic recovery to be able to pare back their extraordinary stimulus. While some question the Fed’s credibility at this point and see Bernanke as a repeat offender for shocking financial markets, there could be other shifts going on at the Fed that have caused them to make this decision.

Earlier this year, it created a huge turn in financial markets when the Fed announced that they begin the withdrawal of their asset purchases later in the year. Immediately there was a huge selloff in all markets spanning from equities to bonds to commodities. The only asset for some stability was the US dollar. That helps explain the reaction Wednesday, when the markets took the complete opposite reaction to the Fed’s decision to delay the much anticipated taper. And if Chairman Bernanke tried his best to make clear one single point, it was that the Fed’s decision to taper was and always has been dependent on the economic data. Despite analysts and financial media over-interrupting his press conferences and meeting minutes, data indicating an improvement in the underlying US economy will allow the Fed to taper. Wednesday signalled that day is not yet here.

The job market had provided the best indication for market analysts for the direction of Fed policy. That is why, in an economic recovery, when those numbers are released each month so much weight goes to what they reveal. In this newsletter a few weeks back, discussing August’s weak payroll report, I suggested this could give voting members uncertainty about the upcoming decision to taper, and create the potential for a few months delay, and that is exactly what we saw. Where the Fed used the unemployment rate as yardstick for the quantity of asset purchases to be made on a monthly basis, they realized that their yard stick was no longer the right measuring tool for the State’s economic performance.

Bernanke cited problems with US job creation. Particularly as we enter a period of decreasing labour force participation, and a retiring boomer population that is not being replaced by a workforce with the same skill set. Thus an unemployment rate of 7 percent to allow for tapering asset purchases looks more like some arbitrary goal than one of actual substance. Better signs for the US employment front can be found in the 4 week moving average of weekly jobless claims as that number indicates almost 40 thousand fewer Americans file for unemployment benefits on a weekly basis as did 4 months ago; however, job creation is the foremost issue, and there are still 7 million Americans either under or unemployed since the peak before this crisis began.

Going forward, it’s truly important that investors make themselves cognisant of two issues. These encompass the realm of possibilities in decisions that could come from the US Fed. Tapering can occur at any instance between now and the Fed’s next meeting. It may not, but eventually the taper is inevitable. This could throw a bit of a curveball at the markets. Despite the Fed’s asset purchases as of late being more impactful on sentiment, any announcement regarding change (or lack thereof) can act as a shock to the financial system.

The second is that investors may want to position themselves for an even more dovish Federal Reserve. While some argue Bernanke went back on his word or misled investors, I would suggest (with full credit to Pimco’s Bill Gross) that the shift is beginning to see Fed Vice-Chair Janet Yellen’s influence increase even more. Thus, this is why the market priced in her leadership overseeing the Fed Funds rate unchanged for a longer time horizon.

Although there are many uncertainties, one thing is clear; despite the Fed’s increased transparency and despite their efforts to provide forward guidance—against all efforts to the contrary they still have the ability to send financial markets for a tailspin.

The market quietly awaited the August jobs report Friday with premarket trading and futures markets remaining little unchanged ahead of the reading. For the last while, this has been the foremost important monthly event that provides investors with some sort of indication into the direction of US Federal Reserve policy, and thus anticipation for the future course of financial markets. As the Wall Street Journal put it quite succinctly, it’s “the ever-so-brief moment the interests of Wall Street, Washington, and Main Street are all aligned on one thing: Jobs.” Of course as events unfold in Syria and the thought of a US led intervention has investors holding off on returning to the stock markets following a directionless summer, but without a catastrophic blow up in the Middle East, Fed policy will continue to guide markets.

To be upfront and clear, expectations for a September taper are now diminishing, and for the Fed to delay by one month would not be unlikely. Prolonged easing would be a friend of the equity markets as the gains since 2009 have been somewhat exponential thanks to the US Fed’s assistance. But it is the fact that the ever so moderate gains in US job creation are pointing towards sustained, albeit, minute improvement for their labour market. In reality, their labour market still leaves much to be desired. To look into the sectors where job gains are posted, they belong to the retail, service, and hospitality industries. Traditionally, these are sectors where growth is not indicative of an expanding economy. It would be optimal to see the employment in construction and manufacturing moving significantly higher.

Labour force participation, which is in my opinion one of the foremost important numbers to follow, is at its lowest level since August of 1978. And what this translates to is that the percentage of Americans that make up their labour force is diminishing. More and more Americans thus require some form of Social Security or assistance from government as fewer working Americans contribute to these government programs. This is one of the many structural problems the US faces, and these are the pertinent budgetary issues that continue to be left unaddressed over the long term.

The other big shift in the labour market has to do with downward revisions made to the estimate of job creation in the months prior. As the US created 169 thousand jobs in August, both June and July were revised down by a total 74 thousand jobs. Instead of averaging 170 thousand jobs created in the last 3 months—that number sits closer to 145 thousand. That’s fairly significant considering it was the improving prospects of the US labour market that was influencing the US Fed to taper asset purchases come September.

The idea of a September taper is now getting increasingly difficult to call by the day. And again, this has to do with the two aforementioned factors. The first being the questionable jobs data that comes out on a monthly basis and spans from unimpressive to mediocre. The second is the uncertainty created around a US led intervention in Syria. This really gives no indication what might happen in the days ahead, but on one thing we can be certain is the US in Syria has investors wanting to hold gold; moreover, any delay beyond expectations in terms of tapering asset purchases will drive demand for gold.

An Aside: The debate surrounding who should be the next Chairman of the US Federal Reserve is getting increasingly more ridiculous by the day. The seven appointed governors (including the chairman) of the Fed board all vote in unison and it’s the conditions of the economy that warrant and determine policy over the CV of the candidate. Where someone might have more influence on economic policy would be as the Secretary of the Treasury Department or as the Director of the National Economic Council for President Obama designing a TARP bailout package (posts Larry Summers has held). Thus, it’s a little surprising this debate over the qualities of Larry Summers is just happening now.

Six years after a recession that rocked the global financial system, there is no shortage of excitement. Especially during a season that is known as the “doldrums of summer,” it has been a week that has propelled equity markets to record levels. On Thursday of this past week, the NASDAQ touched levels not seen for the last twelve years, and the Standard and Poor’s 500 broke and closed above the physiological level of 1,700 for the first time in history. The FOMC released their most recent policy announcement on Wednesday, and continued to distinguish for investors that tapering QE is independent of tightening credit conditions by raising interest rates. The other big news stories were the US Commerce Department’s initial estimates for second quarter GDP, followed by Weekly Jobless Claims report where the number of American’s filing for unemployment benefits drop to the lowest level in 5 and ½ years. And Friday, the marquee event is the always market consuming monthly labour survey or monthly unemployment report.

So as an investor – is it time to be cautious?

Let’s start with the FOMC. They really have no choice but to start tapering their asset purchases, and frankly this point has not been made clear enough. Currently, their monthly purchases of 85 billion break down between mortgage securities and long term treasuries in the amounts of 40 and 45 billion respectively. Annualized, that is 540 billion in treasury purchases. Many economists have estimated that the Fed is currently purchasing anywhere between 60 and 75 percent of the issued treasuries from auction in 2012. Moreover, as the Congressional Budget Office estimates the US Treasury to run smaller deficits in the upcoming years, the market does not require this much support. More to this though is that it exemplifies the role to which the US Fed plays in the treasuries market; Ben Bernanke and his board of governors have to be nervous about the long term consequences of this program, and thus will be looking to draw it down.

According to the Commerce Department though, the US economy looks to be regaining its footing. Quarterly GDP reported on Wednesday of this week came in seven tenth of a percent greater than anticipated. This compensated for the miss in the first quarter of 2013, but the caveat is initial estimates for quarterly GDP have been revised lower on the last four occasions. It the reason the markets shrugged off the reading at first glance as it is still not all that convincing. The other reason for caution, is historically nominal economic growth below 3% has preceded negative real growth and recession. Despite modest upticks in the Fed’s medium and long term outlooks for inflation, currently inflation is practically non-existent; therefore, the economy is more likely to underperform in months ahead.

Good news can be taken from Thursdays jobless claims though as the fewest number of Americans filed for unemployment benefits in over 5 years, and this is a piece of the data that continues to illustrate the merely modest improvements being made in the labour market. And that is why Friday’s July survey becomes all that important. More than the jobless rate, the participation rate will illustrate whether discouraged workers are re-entering the labour force, and as well whether or not the private sector can continue to be the engine of job creation.

This action packed week of what is supposed to be the summer slowdown will set the stage for financial markets going into fall. No question the debate around the Fed’s taper schedule will grow louder and louder, but as an investor the nominal amounts of their bond purchases is of miniscule significance. What is more important is this labour market needs to see gains in participation and quality full time jobs, and this economy requires enough steam to escape a period of disinflation. If not, don’t worry about the doldrums of summer; worry about the doldrums of the United States.

“The economic recovery has continued at a moderate pace in recent quarters despite the strong headwinds created by federal fiscal policy,” was Ben Bernanke’s opening line when delivering what is expected to be his final testimony before the often unpredictable US congress on Wednesday. Only if congress was smart enough to realize he was taking a shot at them. But as his testimony continued, he seemed to create a bit of a wobble in the markets, only to see them in turn trade higher as he reaffirmed the point that the fed intends to slow asset purchases this year should the US economy continue to grow stronger.

The main point of Bernanke’s testimony, and it is a central one that many continue to miss, is that US monetary policy is not on a predetermined course. While many are expecting the US Fed to begin to “taper” come September, they will only do so should the economy continue to show signs of improvement. It is strictly the data that drives the decision making for the Fed, and not what many believe to be the intuition of a bunch of policy wonks at the central banker.

That being said, this is particularly why Bernanke still sees easy monetary policy going forward as unemployment is still high and only making its way down gradually. And as gradual and moderate have probably been the most frequently used adjectives out there to describe this recovery, they speak to the point that improvements in the US labor market have been anything but robust.

The other roadblock continues to be that the measured level of inflation is under their targeted level, so in this regard there is no pressure to tighten monetary policy. Not only would tightening be premature, but also it almost becomes too restricting or unproductive. Albeit, as asset purchases may indeed slow from the US Fed, they continue to provide the forward guidance to let creditors and borrowers know that interest rates will stay low until at least 2015.

The explanation of the Fed’s policy approach highlights the three distinct policy tools in which they may interact in the economy: asset purchases (QE), setting interest rates (the Fed Funds Rate), and forward guidance (offering insight into policy direction). And despite the media not often being able to differentiate between the three, the Fed continues to present their objectives, which carry implications for the financial markets. It is the notion of forward guidance, however, that despite not being a substantive tool in the sense that it does allow the Fed direct interaction into the financial markets—it seems to have the most impact.

Forward guidance offered by the US Federal Reserve affects the market in what might be thought of as fed induced volatility. To the gold market, we know it as “buy the rumour, sell the news” because it was the announcement of a new policy of increased treasury purchases that created the catalyst for a rally, instead of the actual event.

For many investors who bet on the failings of a US recovery, we seemed to have hit a roadblock. To reference back to the opening sentence borrowed from Chairman Bernanke’s testimony, fiscal policy has been the biggest drag on the economy. However, that being said, the economy is improving. The US Fed utilized imperfect tools to try and assist in what seemed to be a hopeless task. The problem is financial markets don’t seem to worry about patching a hole in the roof when the sun is shining. We can talk all we want about how doomed the US social safety net programs are and how dysfunctional their system of governance is, but ultimately we’ll have to wait for the repercussions until it starts to rain again in the markets.