Investors Are Too Complacent Ahead of the Major Risk from the Debt Ceiling Crisis
Wall Street is hesitating. On the eve of the Labor Day weekend, the Dow Jones index flirted with a 22,000 points closure. But as investors relaxed, perhaps many must have come to the realization that the stock market is performing unrealistically. Stock prices are too high. One factor that could help cement more “realism,” however, has gotten little attention. It’s the U.S. debt ceiling crisis.
The thing about the debt ceiling crisis is that it comes with baggage. That baggage being the overall sensation that the institutions that help guide the markets are approaching paralysis. The Federal Reserve is experiencing the very definition of a catch-22 situation. It should raise interest rates because the current nominal rate is too low. Thus, it is encouraging investors to take risks that they won’t be able to come back from when the crash comes.
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Yet, if the Fed does decide on another rate hike before the end of 2017, it could spell disaster. The Dow has reached such lofty heights that the fall will be painful indeed. While the Fed tries to swim through these shark-infested waters, politicians and bankers will have to tackle the problem of U.S. public debt and the growing possibility of a U.S. government shutdown. Still, even the solution—taking more debt—will only worsen economic prospects. U.S. debt as a percentage of gross domestic product (GDP) is already at alarming levels.
The Debt Ceiling Risk
Apart from North Korean leader Kim Jong-un’s binoculars, portfolio managers will be watching the political debate in Congress closely. They expect turbulence, given the fact that Republicans and Democrats have still failed to reach an official agreement over the debt ceiling.
Investors should pay close attention to the negotiations on the federal debt ceiling. Earlier this year, the U.S. Treasury set September 29 as the deadline for Congress to vote whether or not to take on more debt. Doing so would add to the almost $20.0 trillion that the U.S. has accrued. But without the legal authority to borrow more, the United States could come to grinding halt.
Then, on September 6, Trump sided with the Democrats on a deal to temporarily raise the debt ceiling until December 15 to help with Hurricane Harvey response efforts. This only shows how contentious the issue has become. Rather than push for an agreement, Trump’s effort might persuade some Democrats to stall and many Republicans—not all agree with Trump—to push harder.
In other words, it is essential for the government to keep working—that includes many essential services that make it possible for capitalism to do its thing—to secure additional federal funding. This funding would come from Congress agreeing to an increase in the debt ceiling.
In 2013, the closure of 18 days (September 30 to October 17) did not unduly hurt the stock markets. But in 2011, as Standard & Poor’s lowered America’s credit rating, the S&P 500 Index fell by about 15%. Note that this was before the huge market rally of the past year. The higher you go, the harder you fall, as they say.
The Dow and the NASDAQ have broken all records without any solid economic data to account for their bullish outlook. Investors fear that the highly contentious political environment could even cause vicious debates within the Republican party. That would stall the administration. President Donald Trump will likely react by threatening federal closures if he does not get funding for the wall he has agreed to build on the Mexican border. That would then prolong the suspense of a government shutdown beyond December 15 and into 2018. The markets would find such uncertainty difficult to sustain. Combined with the other risk factors, the overall environment spells market crash.
