Looming debt limit fight rattles Wall Street

Looming debt limit fight rattles Wall Street
© Getty

Wall Street is nervous that political deadlock in Washington and a looming debt ceiling fight could lead to the unthinkable this year: a U.S. debt default.

“Washington has not been able to get a single thing of substance done since this Congress was established, so given that, there are a lot of reasons to be nervous that they won’t get it done,” said Mark Zandi, chief economist at Moody’s. 

“I think it’s important to be on high alert. I don’t think I’m on DEFCON 1 yet, but I’m on the scale,” he added.

ADVERTISEMENT

Treasury Secretary Steven MnuchinSteven Terner MnuchinThe Hill's Morning Report - Trump says no legislation until Dems end probes Democrats seize on IRS memo in Trump tax battle No agreement on budget caps in sight ahead of Memorial Day recess MORE has told Congress that if it doesn’t take action on the debt ceiling by Sept. 29, the government will not be able to pay its bills. While most analysts believe Congress will act in time, the uncertainty weighs on the market.

“Congress will likely raise the debt ceiling or suspend it, allowing the U.S. government to resume normal debt issuance and financing activities. However, in the next several weeks, U.S. short-term bond markets could be choppy,” Justin Mandeville, a portfolio manager at Invesco, wrote in a note Friday.

The yield on Treasury bills set to expire after October have already spiked somewhat, a sign of investor concern about the prospects of default. 

Raising the debt ceiling is unpopular. A June Harvard–Harris Poll survey found that 69 percent of voters opposed raising the ceiling, though other surveys have shown that most Americans don’t fully understand the economic repercussions of failing to lift it.

Conservative Republicans see the debt vote as an opportunity to push through spending restrictions. Democrats, who would have to provide some support for the measure in the Senate, find such restrictions anathema. In recent years, Republican leaders in Congress have relied on Democratic votes to pass the ceiling. 

With President Trump in the White House, however, Democrats may not be as inclined to help Republicans on the difficult vote.

“The fact that it creates even some uncertainty is why we feel it is not positive for the economy and why we don’t have the U.S. on a higher rating level,” said Lisa Schineller, managing director of sovereign ratings for S&P Global Ratings. 

The ratings agency famously downgraded the U.S. credit rating in 2011 following a too-close-for-comfort debt ceiling negotiation.

Those close calls and credit downgrades cost taxpayers. The Government Accountability Office estimated that the 2013 debt limit fight added between $38 million and $70 million in increased borrowing costs to Treasury bills issued at that time. 

Current inaction is also costly. Since March, when the U.S. actually arrived at the debt limit, the Treasury has been using “extraordinary measures,” or borrowing loopholes, to keep paying the debt. Sen. James LankfordJames Paul LankfordBipartisan group of senators introduce legislation designed to strengthen cybersecurity of voting systems Dems push to revive Congress' tech office US-China trade talks end without announcement of deal MORE (R-Okla.) estimated those measures — which are what Mnuchin estimates will be exhausted by Sept. 29 — had cost taxpayers $2.5 billion.

“The fact that it creates even some uncertainty is why we feel it is not positive for the economy and why we don’t have the U.S. on a higher rating level,” said Schineller.

In some sense, the fact that the debt fight has become standard protocol has given markets a false sense of comfort that everything will work out, said Zandi.

“I do worry a little bit about the complacency around it. To some degree, investors are complacent because they think they know the outcome,” he said.

As the deadline approaches, inaction could further damage the U.S. government’s financial credibility, adding to borrowing costs.

“The markets aren’t as easy to predict, because it’s psychology at this point. The market psychology will be affected by the perception of the imminence of a deal,” said Brian Riedl, a senior fellow at the Manhattan Institute and a former Senate Finance subcommittee staff director.

If the deadline comes and goes, markets will likely react with alarm, but the U.S. will not technically default until its next debt payment comes due. 

"You’d see the stock market down several hundred points, we might see interest rates go up, the gap in credit spreads would go up,” Zandi said. 

One reasons markets expect action is that Congress will feel the heat if markets start getting jittery. 

“Presumably, the pressure, the turmoil in markets, the loss of wealth in the stock markets and bond markets would create a firestorm of criticism. Every senator and congressman would be getting calls from everyone, including their donors,” said Zandi.

But even crossing that line briefly could leave permanent scars on the economy, as the previous debt fights have.

“The status of U.S. Treasuries as the cornerstone of the global financial system [is at risk]. We would be throwing away a national asset, as well as risking a global financial crisis,” said Lou Crandall, chief economist at Wrightson ICAP, LLC.

That would affect the standard of living for every American for years to come. 

“It’s just unthinkable,” Crandall said.