Analysis-Wall Street nervous about Washington as debt ceiling warnings sound

NEW YORK (Reuters) – The slim but growing possibility of a budget crisis if Congress does not act on the debt ceiling is increasingly gaining the attention of U.S. investors and spilling over to some asset prices, although few believe that the nation will eventually default.

FILE PHOTO: Traders work on the floor of the New York Stock Exchange (NYSE) in New York, United States, September 29, 2021. REUTERS / Brendan McDermid / File Photo

Warnings have been issued by policymakers to Wall Street bankers about the risk of the talks failing. Jamie Dimon, chief executive of JPMorgan Chase & Co, said the bank was bracing for what could be a “potentially catastrophic event,” while New York Federal Reserve Chairman John Williams warned against a potential negative reaction from the market if no solution is found to the debt. -ceiling problem.

“The legislative schedule is very busy over the next few weeks and there are significant extreme risks in the near term,” said Jon Adams, Senior Investment Strategist at BMO Global Asset Management. “Our point of view is that in the end, colder heads will prevail.”

Some signs of nervousness are appearing in US markets as the US Congress faces two looming deadlines to fund the government and tackle the country’s $ 28.4 trillion debt ceiling. He has a deadline of September 30 to avoid the start of a shutdown of government services. Secretary Janet Yellen urged Congress to act before October 18 to avoid “serious damage” to the economy.

“If the government shuts down that’s okay, but if it keeps playing with the debt ceiling it can cause big problems” and lead to a massive sell-off in the financial markets, said Randy Frederick, director General of Trading and Derivatives for the Schwab Center for Financial Research.

The growing possibilities that Congress will not act in time to prevent a shutdown or default have been cited by some as contributing to stock weakness in recent days. In forex markets, some analysts believe that concerns about the debt ceiling have helped boost the US dollar.

The situation remains at an impasse. Democrats in Congress said on Wednesday they would vote to avoid an impending government shutdown before funding expires at midnight Thursday. The House and Senate can vote on a separate bill that temporarily lifts the debt limit, but Senate Republicans are refusing to vote for it.

Yet since the United States has already been on the wire on this, investors have expressed a nonchalant view on the matter.

“It’s unclear whether the market really cares about the debt ceiling,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. “If you’re pretty rational, you probably aren’t, because it resolves one way or another. On the other hand, it is a risk that you cannot ignore.

Wells Fargo analyst Michelle Wan wrote on Tuesday that investors have so far “responded with a shrug” to the impending deadline, with complacency “rooted in past compromises that have avoided defaults. payment and other payment interruptions “.

The nervousness about the debt ceiling, however, manifested itself in the treasury bill market. Michael Purves, CEO of Tallbacken Capital Advisors in New York City, wrote in a note Monday that tensions were seen in the pricing of three-month invoices which “are unlikely to be burdened by the risk of default” compared to one-month invoices. month. Yet that has yet to reflect the most spectacular peaks of 2011, 2013 and 2015, Purves said.

One-month bills currently earn 0.07%, higher than three-month bills which earn 0.04%. At the start of the year, both lost around 0.08%.

Portfolio managers generally avoid problems with risky invoices of default, even if the probability of a failed payment is very low. This can cause yields on some issues to be higher than those on longer-term debt, an unusual phenomenon in the yield curve, which is generally sloping upward.

Debt ceiling constraint:

BMO analysts said that “as investor attention remains focused on Washington, the distortions” at the front of the yield curve “can likely persist until a deal is struck.”

Another sign of concern, TD analysts noted a sharp increase in US credit default swaps traded in small quantities.

Past crises have shaken the market – but only temporarily. A technical default and a downgrade in the US debt rating in 2011 helped push the S&P 500 nearly 20% off its peak before it rebounded.

Weakening effects of debt ceiling freezes:

Another prolonged debt ceiling negotiation in 2013 caused the S&P 500 to fall 5.8%, but there was little market reaction to similar deadlines in 2016 or 2018, as Wall Street began to fall. seeing the threat of crisis as fabricated, said Sam Stovall, chief investment strategist at CFRA Research.

Yet sensitive markets such as money markets have not shown increasing levels of panic, according to Peter Crane, head of Crane Data, which focuses on the money market sector.

“They could stop at the last minute, but everyone knows both sides are bluffing,” Crane said.

Reporting by David Randall, additional reporting by Karen Pierog, editing by Megan Davies and Nick Zieminski

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