Biden officials argued that a debt ceiling bill passed by McCarthy last month would weigh on the economy and kill jobs. There is now a possibility that the White House will agree to a spending limit at a time when markets are already facing significant uncertainty due to rising borrowing costs and growing dissatisfaction with the economy.
“I don’t know exactly how the market is going to react,” said Jenny Johnson, president and CEO of mutual fund giant Franklin Templeton, in an interview at a Manhattan conference on Wednesday.
The months-long drama has angered financiers already grappling with other headwinds.
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“It’s embarrassing for a country that we’re getting to this point,” Johnson told the audience. While she is confident that policymakers will reach an agreement and that the US will maintain its dominance in financial markets, the repeated crises are “weakening” investor confidence.
That could affect how Wall Street reacts to any deal Biden negotiates with GOP leaders.
In some respects it is remarkable that they have not faltered. Municipal and mid-market financial institutions are gradually withdrawing from the credit markets after a wave of regional bank failures. Consumer confidence indicators are flashing red. And while Americans continue to spend, major retailers and bank card details suggest they’re starting to collect.
Meanwhile, inflation has lingered longer than Federal Reserve Chair Jerome Powell would like. Powell and other Fed leaders have signaled they are unlikely to cut interest rates until they are confident that price spikes are under control.
Even under the best of circumstances, that would be difficult territory for Biden and Republican leaders. But with the federal government just weeks away from throttling Treasury payments on securities that rate everything from mortgages to municipal bonds, the public’s confidence in their ability to grow the economy is now at risk steer, continues to dwindle.
The possibility of an economic downturn — without the promise of relief in the form of rate cuts — will affect how the market takes to the deal Biden and McCarthy are making on the debt limit. While McCarthy’s debt ceiling bill included energy reforms and other changes likely to cheer markets, it also includes significant spending cuts that could unsettle traders if the economy worsens.
That came in 2011 after President Barack Obama and the Republicans announced a deal just two days before the Treasury Department’s “X-Date.”
“It was almost paradoxical, but the stock market, the S&P 500, fell after the debt ceiling was breached,” Reynolds said.
In 2011, stocks started tumbling in late July — about 10 days before the “X-date” on August 2 — and continued to fall until President Barack Obama and Republicans announced a deal on July 31.
The bloodbath didn’t stop there, however.
Two days after Obama signed the debt ceiling bill, the stock market reported its worst losses since the financial crisis as traders pondered how the deal – which forced significant spending cuts – would affect an economy still mired in mud .
On August 5th, S&P announced a historic decision to downgrade US Treasury bonds, further pushing equity markets lower. Market volatility increased and the main indices that track the development of the stock market did not recover until the following year.
Even if Congress passes a debt limit bill to Biden before June 1, a downgrade — which would drive up the cost of borrowing for both governments and consumers — remains a threat.
Richard Bernstein, the former longtime chief investment strategist at Merrill Lynch who now heads an investment firm of the same name, said he believes the probability of a downgrade is now over 50 percent. Yellen and other Biden administration officials, in speeches and meetings with lawmakers, have raised the specter that the US could lose its prime credit rating.
Still, the economy is much more resilient than it was after the global financial crisis. Unemployment is at a fraction of what it was in 2011. Households and businesses were cash-rich when the Fed began raising interest rates last year, giving them a solid cushion to absorb losses as higher borrowing costs took hold.
Equally important, while House Republican leaders are now pushing for spending cuts — something leaders have said could help cool inflation — they could easily back down if an economic downturn begins to hit the red districts, said RSM-US chief economist Joe Brusuelas.
While new spending caps are binding, “the current trajectory of negotiations between the White House and Congress strongly suggests that the caps introduced will not limit the Treasury Department’s ability to respond to all needs in the event of a recession.” he said.
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