A political stalemate over raising the debt ceiling – again – hangs over increasingly gloomy market prospects, prompting economists to warn that taxpayers could be the ones paying the price for politicians’ intransigence.
Treasury Secretary Janet Yellen said that since the reinstatement of the debt ceiling last month, the department had taken “extraordinary steps” to keep its ability to finance the government intact. “Once all available measures and the available money are completely exhausted, the United States of America would not be able to meet its obligations for the first time in its history,” she said in a statement. letter to chamber and committee leaders last week, estimating that fiscal D-Day could arrive in mid-October.
A fiscal D-Day could arrive as early as mid-October, Yellen warned.
Playing chicken with US sovereign debt could come at huge costs, said Mark Zandi, chief economist at Moody’s Analytics.
“T-bill yields are what are called risk-free interest rates for a reason… If there is any sense that the Treasury will not pay on time, it shakes the confidence of global investors. Interest rates will skyrocket, the stock market will dive, ”he said, adding that future generations of Americans would ultimately bear the cost. “The problem is that investors are going to demand a higher interest rate forever, so it’s going to cost us a lot,” he said.
Debt ceiling is eternal political football in Washington, but market watchers say the stakes are higher this time around as the idea of raising the country’s borrowing limit merges with plans Democrats to raise taxes and deploy a significant expansion of Social Security. net without Republican support. GOP leaders have said that since Congressional Democrats plan to use the budget reconciliation process to advance President Joe Biden’s agenda along party lines, they should increase the debt ceiling in the same way.
“It’s a talking point that Republicans can use to push back” some of the Democrats’ spending plans, said Joseph LaVorgna, managing director and chief economist of the Americas at Natixis. He pointed out that the market has already been frightened by rising inflation, which he says could get out of hand if billions of dollars more of fiscal stimulus in the form of infrastructure investments and “human infrastructure” are injected into an economy already struggling with shortages and bottlenecks. both materials and labor.
“This will significantly increase the risk of inflation and have negative implications for interest rates and financial markets,” LaVorgna said.
Critics of the Republicans’ argument point out that the debt ceiling does not allow new spending – the feud is over whether to pay for what the government has already spent. Democrats have accused Republicans of hypocrisy because during President Donald Trump’s tenure lawmakers repeatedly raised the debt ceiling with bipartisan consensus. In 2017, they increased it by $ 1.7 trillion in 2017, and by $ 2.2 trillion just two years later.
“The debt limit was exceeded when Republicans voted for the CARES law in March 2020,” Zandi said. “Republicans voted for it, and now they are unwilling to sign” to pay for the expenses they have authorized, he said.
With both sides digging into their respective corners, Yellen stressed that both sides have a role to play in the ongoing fight. “Congress has addressed the debt limit in recent years through regular ordinances, with broad bipartisan support,” she said.
But in a bitterly divided Washington, any common ground can be elusive. “I think the politics here is a lot more acidic than it was even 10 years ago, and 10 years ago it was bad. We are in a whole new ball game of political resentment, ”Zandi said. “I’m actually more nervous about this go-around than in the past.”
Zandi said some Republican lawmakers had suggested the idea that the Treasury could simply default on some of its debts – for example, by prioritizing certain bondholders – a notion he was quick to develop. to reject. “This is absurd, because as soon as the Treasury doesn’t pay someone, every bond investor in the world knows he’s next,” he said. “It used to be that you didn’t hear these ruminations, but now they are spoken publicly. “
With about a month before the Treasury Interim Measures cease to work, Wall Street is still behaving as if it expects the impasse to be resolved without incident. “You have no choice but to raise the debt ceiling so that you can continue to run the country,” said Tom Martin, senior portfolio manager at Globalt Investments.
Jay Hatfield, CEO and portfolio manager at Infrastructure Capital Advisors, said it was no surprise that Wall Street has so far remained bullish on the matter, suggesting that market participants are concerned about the tax laws by being developed in Congress. “In all this dialogue, this tax policy will be a huge inflection point for the market,” he said.
Early figures released by House Democrats indicate lawmakers have slashed ambitions for their plans to raise taxes on corporations and wealthy Americans. While Biden’s original proposal called for an increase in corporate tax to 28% from the current 21%, the most recent proposal would raise that rate to 26.5% for companies with revenues over $ 5 million. dollars, and lower it for small businesses with incomes below $ 400,000. .
Hatfield said moderation was likely a relief for the markets – a useful boost after a week of pessimistic sentiment that brought major indices down. “I think he needs some support at this point, given the bleak outlook for inflation,” he said.
“Every time the debt ceiling is raised it is an exercise in political stampede,” said Peter Essele, head of portfolio management for Commonwealth Financial Network.
Despite the clatter of the saber, Essele argued that politicians from both parties have too much to lose to play chicken with the country’s credit rating. “It’s basically a self-inflicted injury in the midst of a pandemic. During a time when we are seeing slower growth and above average inflation, it would be political suicide for both sides, ”he said. “There is definitely a situation where they could put us on the brink, but at the end of the day, it’s in the best interests of politicians to fix something.”
Some market watchers fear, however, that a miscalculation – or even a procedural hurdle if Congress goes all the way – could trigger this kind of collapse. US debt was downgraded from AAA to AA + by Standard & Poor’s in 2011. New black ratings on the country’s credit rating would have more serious consequences.
“If you go down a few more notches, it’ll grab people’s attention,” Martin said. “If the extraordinary measures are exhausted and something is missed, I think it gets people’s attention.”
Beyond the rating agencies, the United States would – perhaps permanently – lose its credibility on the global financial scene, Zandi warned. “It would also begin to undermine the viability of the dollar as a reserve currency, as the foundation of the global financial system,” he said.
“Treasury bills are the foundation of the entire financial system. If there was a major disruption to the risk-free rate, the whole house of cards would collapse at that point, ”Essele said. “The consequences of this would essentially be scorched earth in Washington.”