Why a debt-ceiling agreement would bring no joy to investors

U.S. politicians are closing in on an agreement to raise Washington’s debt ceiling. Investors may want to control their excitement.

While an agreement would prevent the outright chaos of the United States defaulting on its debt, markets had never believed that scenario would come to pass anyway.

The likely pact would raise the government’s borrowing limit for two years, but cap most government spending during that time, according to Reuters and Wall Street Journal reports on Friday. It would make an exception to allow for higher military spending but it would claw back increased funding for the Internal Revenue Service.

Nothing was finalized as of Friday afternoon. However, both the S&P 500 and the Dow Jones Industrial Average surged higher, presumably on relief that the debt-ceiling impasse is clearing.

Look more closely, though, and it’s difficult to see exactly what investors are rejoicing about.

For starters, there was never any evidence that the debt-ceiling negotiations had been casting a pall over stock prices.

The S&P 500 had held rock steady over the past month as debt-ceiling tensions had ratcheted higher. The Nasdaq Composite had enjoyed a healthy gain over the same period.

Given the apparent lack of concern in markets over the debt ceiling, it’s difficult to argue that a relief rally should now ensue.

It’s also hard to see any economic rationale for excitement. Caps on government spending will restrain short-term economic growth, not encourage it.

A debt-ceiling agreement will, if anything, create some immediate headwinds for stocks. Since the government’s US$31.4-trillion borrowing limit was reached back in January, Washington has had to resort to what it terms “extraordinary measures” to make ends meet. The Treasury General Account (TGA), out of which it pays its bills, is close to empty.

Replenishing the TGA will require the Treasury to issue massive amounts of new bonds – more than US$1-trillion in the final seven months of this year, analysts at JPMorgan estimate. That will hoover up cash and leave investors with that much less to invest in stocks and other competing assets.

So what do markets have to celebrate? It seems to be nothing more than simple joy that the small but real chance of disaster is shrinking rapidly.

Without a debt-ceiling deal, a default could occur as early as June 1, according to Treasury Secretary Janet Yellen. Analysts at BNP Paribas had pegged the most likely default dates as June 6 to June 8.

The consequences of a default would be massive. The U.S. Treasury would stop paying holders of government bonds, creating pandemonium in financial markets. Washington might have to delay paying its employees and troops, halt Social Security cheques to retirees and stop funding programs ranging from Medicaid to food stamps.

Even if the debt limit were breached only for a week, 1.5 million jobs would be lost, according to Mark Zandi, chief economist at Moody’s Analytics.

This, just to be clear, was never likely. In a report earlier this month, Mr. Zandi put the chance of a default at only 10 per cent.

Still, the fear had been that extremist Republicans might prove intransigent and refuse to countenance any attempt to raise the debt ceiling. Donald Trump, the front-runner for the Republican presidential nomination next year, sent anxiety levels soaring recently when he brushed off the dangers of a U.S. default. The consequences “could be maybe nothing,” he said.

If the latest reports are accurate, a more rational approach is prevailing. This would be in keeping with previous debt-ceiling showdowns in 2011, 2013 and 2021. Politicians thundered and stomped on those occasions but always wound up hammering out last-minute deals.

They seem to be doing the same this time. But they are cutting it awfully close.

Once a deal is reached, it must still be approved by the House of Representatives (which is controlled by the Republicans) and by the Senate (which is controlled by the Democrats).

The House vote is the wild card. Many representatives of both parties are reportedly not happy with the agreement that is shaping up.

Kevin McCarthy, the Republican who serves as Speaker of the House, could face a particularly tough time in persuading members of the House Freedom Caucus, a group of right-wing Republicans, to support a deal. They have said repeatedly that they oppose any compromise.

Chances are that any crisis will once again be averted by a final burst of dickering. The needless dramatics, though, do underline the lunacy that is the debt ceiling.

It is a self-imposed limit on how much Washington can borrow to help pay for the programs that Congress has already approved.

Its purpose has never been all that clear: If Congress doesn’t want to incur debt, why doesn’t it just stop spending or raise taxes? Yet somehow the battle over raising the ceiling has become a regular piece of political theatre that politicians – especially Republicans – use to depict themselves as fierce enemies of government bloat.

Perhaps the amount of time and energy spent in recent weeks on this charade will persuade politicians of both parties that it’s time to retire the debt ceiling once and for all. That would be something to truly get excited about.