The stock market is crashing as the debt ceiling deadlock looms. How bad will it get?

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Failure to meet the debt limit would lead to an unprecedented default on US sovereign debt. Above, House Speaker Nancy Pelosi on October 1.

Kevin Dietsch / Getty Images

It’s made-for-television drama of the worst kind – and the stock market doesn’t want it.

We’re talking, of course, about the hubbub in Washington, where Democrats and Republicans are engaged in inter- and intra-party deadlocks over government funding, infrastructure investments, and the ability of the United States to issue debt. These fights were not lacking in dire predictions, especially with regard to the debt ceiling, which limits the amount the federal government can borrow to meet existing obligations. Failure to meet the debt limit would lead to an unprecedented default on US sovereign debt.

But despite the heightened political spirit, cooler heads should prevail. A US default is a difficult scenario to imagine, and investors should look past any headline-related volatility in the coming weeks. The weakening of the Federal Reserve, potential corporate tax changes in the United States, and the pathways of the pandemic and global economic recovery will determine the medium to long-term direction of the market – not a few weeks d ‘high stakes but a now normal partisan stalemate. Chances are everyone will have forgotten all about the drama in a month.

Still, bickering in Congress weighed on stocks. The


S&P 500 Index

ended the week down 2.2%, at 4,357.04, its worst September since 2011, which occurred during another debt ceiling standoff.

Politics weren’t the only thing hindering actions. Under pressure from rising bond yields, the yield on the 10-year U.S. Treasury bill surpassed 1.54% last week, its highest since June


Nasdaq Composite

fell 3.2% to 14,566.70. The


Dow Jones Industrial Average

fell 471.54 points, or 1.36%, to 34,326.46. He also shattered a five-game winning streak, losing 1.9% from July to October.

There was a lot of movement on the congressional front over the weekend, but the saga is far from over. The Senate and House of Representatives voted Thursday to pass a continuing resolution to fund the federal government until December 3, and President Joe Biden signed it that evening. This avoids a government shutdown for at least the next two months. A vote on the infrastructure bill last Thursday was delayed, with Democrats on either side of the party continuing talks on a separate reconciliation budget focused on “social infrastructure” and climate change provisions.

These remain ancillary to the main act, the debt ceiling. On Wednesday night, in a largely partisan vote, the House passed an extension of the debt ceiling, which would increase the amount of money the treasury is allowed to borrow to pay federal government bills. Getting to the Senate remains a longer battle: Democrats say they don’t want to add the increase to their ongoing reconciliation plan, while Republicans say they won’t agree to a stand-alone increase in the ceiling of the debt.

The clock is turning. Treasury Secretary Janet Yellen has designated October 18 as the date when her department will run out of budget maneuvers to continue meeting its obligations. This is effectively the deadline for Congress to act to avert a US government default. Bond yields could continue to rise – and stocks could continue to fall – as we get closer to that date without increasing or suspending the debt limit.

It is not yet time to worry. The last major debt ceiling battles took place in 2011 and 2013, and were fought between the Obama administration and Republicans in Congress. The end result was an increase in the cap each time, avoiding a fault, but not without damage. Standard & Poor’s, one of the top three rating companies, downgraded the creditworthiness of the US federal government to AA +, from AAA, following the 2011 deadlock. In 2013, Fitch placed US government debt under negative watch, finally maintaining its rating at AAA.

For now, the rating agencies seem confident that these battles are part of the process and will be resolved flawlessly. “With respect to our analysis of the US sovereign rating, we expect Congress to address the debt ceiling on time, either raising it or suspending it, knowing that the consequences for financial markets of not being not to do so would be serious and extraordinary, ”explained S&P. in a note Thursday. “It would be unprecedented in modern times for an advanced G-7 country like the United States to default on its sovereign debt. “

Financial markets seem to agree. Despite recent declines, neither stocks nor bonds significantly reflect the worst-case scenario of a US debt default. For now, at least, they expect Congress to act on time, as it has in the past. It doesn’t change the fact that lawmakers are playing a high-stakes chicken game, one that might not end until the mid-October deadline, especially if they don’t feel the pressure of a market. stock market in free fall or soaring. Treasury yields.

“[Does] does the stock market have to sell to get politicians to act? Writes Chris Harvey, head of equity strategy at Wells Fargo Securities. “If substantial progress is not made by mid-October, we believe the markets will kick in.”

The impact could be more on some titles than on others. David Kostin, For the Stock Market, Taxes Trump StimulusGoldman Sachs, chief U.S. equities strategist, has compiled a list of some 80 companies with at least 20% of their income coming from the U.S. government. He understands


Lockheed Martin

(symbol: LMT),


Booz Allen Hamilton Holding

(BAH),


Humana

(HUM), and


UnitedHealth Group

(A H). Notably, the predominantly industrial and healthcare equity group has underperformed the market in the last two debt limit disputes and has fallen behind the broader market in recent times.

But for the stock market as a whole, the last two encounters with the debt ceiling weren’t particularly important, Kostin says, with the macro environment at the time having more influence. The S&P 500 fell during the 2011 struggle, but this coincided with the European sovereign debt crisis and slowing economic growth. Shares also sold sharply after the S&P downgrade, which came four days after Congress raised the debt ceiling, but climbed in the following months. The macroeconomic context was more favorable in 2013 and equities rose despite this deadlock on the debt limit.

In 2011, Congress acted on the debt ceiling just two days before the Treasury declared it would be unable to pay its bills, and a quick resolution doesn’t appear to be in the cards this time around either. But subsequent market volatility over the next two weeks has to be seen like this: two weeks of volatility.

Barring a default, the current struggle will not determine the direction of the market any longer than that.

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com


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