The Stock Market Slumped Because the Debt Ceiling Standoff Rekindled Memories of the Worst Kind
Failure to address the debt limit would result in an unprecedented U.S. sovereign debt default. Above, Speaker of the House Nancy Pelosi on Oct. 1.
Kevin Dietsch/Getty Images
It’s made-for-TV drama of the worst kind—and the stock market wants none of it.
We’re speaking, of course, of the hubbub in Washington, where Democrats and Republicans are engaged in inter- and intra-party standoffs over government funding, infrastructure investments, and the U.S.’s ability to issue debt. Those fights have produced no shortage of dire predictions, especially regarding the debt ceiling, which constrains how much the federal government can borrow to meet existing obligations. Failure to address the debt limit would result in an unprecedented U.S. sovereign debt default.
But despite the heightened political brinkmanship, cooler heads should prevail. A U.S. default is a hard-to-imagine scenario, and investors should look past any headline-driven volatility over the next few weeks. Federal Reserve tapering, potential U.S. corporate tax changes, and the paths of the pandemic and global economic recovery will determine the market’s medium- and long-term direction—not a few weeks of high-stakes but now-normal partisan deadlock. Chances are everyone will have forgotten about the whole drama a month from now.
Still, the Congressional wrangling has weighed on stocks. The S&P 500 index finished the week down 2.2%, at 4357.04—notching its worst September since 2011, which occurred during another debt-ceiling standoff.
Politics wasn’t the only thing hurting stocks. Pressured by an increase in bond yields—the yield on the 10-year U.S. Treasury note topped 1.54% this past week, its highest since June—the tech-heavy Nasdaq Composite dropped 3.2%, to 14,566.70. The Dow Jones Industrial Average fell 471.54 points, or 1.36%, to 34,326.46. It also broke a five-quarter winning streak, losing 1.9% from July to October.
There was plenty of movement on the Congressional front late in the week, but the saga remains far from over. The Senate and House of Representatives voted to pass a continuing resolution on Thursday to fund the federal government through Dec. 3, and President Joe Biden signed it that night. It avoids a government shutdown for at least the next couple of months. An infrastructure bill vote this past Thursday was delayed, with Democrats on either end of the party continuing talks on a separate reconciliation budget focused on “social infrastructure” and climate change provisions.
Those remain sideshows compared with the main act—the debt ceiling. On Wednesday night, in a largely party-line vote, the House passed a debt-ceiling extension, which would increase the amount of money the Treasury is allowed to borrow to pay the federal government’s bills. Passage in the Senate remains a longer battle: Democrats say they don’t want to add the increase to their in-progress reconciliation package, while Republicans say they won’t go along with a stand-alone debt-ceiling increase.
The clock is ticking. Treasury Secretary Janet Yellen has designated Oct. 18 as the date when her department runs out of fiscal maneuvers it can take to keep meeting its obligations. It’s effectively the deadline for Congress to act to avoid a U.S. government default. Bond yields could continue going up—and stocks could continue going down—the closer we get to that date without a debt-limit increase or suspension.
It’s not time to worry yet. The last major fights over the debt limit took place in 2011 and 2013, and were waged between the Obama administration and Republicans in Congress. The eventual result was an increase in the ceiling both times, avoiding a default, but not without damage. Standard & Poor’s, one of the three major credit-ratings firms, downgraded the U.S. federal government’s creditworthiness to AA+, from AAA, in the aftermath of the 2011 standoff. In 2013, Fitch put U.S. government debt on a negative watch, ultimately keeping its rating at AAA.
For now, the credit-ratings firms seem confident that these battles are part of the process and will be resolved without a default. “With respect to our U.S. sovereign rating analysis, we expect that Congress will address the debt ceiling on time, either raising it or suspending it, understanding that the consequences on the financial markets of not doing so would be severe and extraordinary,” S&P explained in a note on Thursday. “It would be unprecedented in modern times for an advanced G-7 country, like the U.S., to default on its sovereign debt.”
The financial markets appear to agree. Despite recent declines, neither stocks nor bonds are meaningfully reflecting the worst-case scenario of a U.S. debt default. For now, at least, they expect Congress to act in time, as it has in the past. That doesn’t change the fact that lawmakers are playing a high-stakes game of chicken, one that might not end until awfully close to the mid-October deadline, especially if they don’t feel the pressure of a tumbling stock market or surging Treasury yields.
“[Does] the stock market need to sell off to shock politicians into action?” writes Chris Harvey, head of equity strategy at Wells Fargo Securities. “If substantial progress is not made by mid-October, we think the markets will get into the act.”
The impact could fall more on some stocks than others. David Kostin, For the Stock Market, Taxes Trump StimulusGoldman Sachs’ chief U.S. equity strategist, tallied a list of some 80 companies with at least 20% of their revenue coming from the U.S. government. It includes Lockheed Martin (ticker: LMT), Booz Allen Hamilton Holding (BAH), Humana (HUM), and UnitedHealth Group (UNH). Notably, the group of mostly industrial and healthcare stocks underperformed the market during the past two debt-limit conflicts and has lagged behind the broader market lately.
But for the overall stock market, the last two debt-ceiling showdowns weren’t particularly significant, says Kostin, with the macro environment at the time having more of an influence. The S&P 500 declined during the 2011 fight, but that coincided with the European sovereign debt crisis and slowing economic growth. Stocks also sold off sharply after S&P’s downgrade, which came four days after Congress raised the debt ceiling, but climbed in the following months. The macro backdrop was more favorable in 2013, and stocks rose through that debt-limit standoff.
In 2011, Congress acted on the debt ceiling just two days before the Treasury said it would be unable to pay its bills, and a quick resolution doesn’t appear to be in the cards this time either. But subsequent market volatility over the next two weeks should be viewed as just that: two weeks of volatility.
Short of a default, the current fight won’t determine the market’s direction any longer than that.
Write to Nicholas Jasinski at [email protected]
