US politics in focus
Politicians in Washington are once again wrangling over the budget. It's a return to the pre-pandemic norm, so in a certain way, it could be an optimistic sign. While the media has focused on the political implications of this, the markets appear so far to have generally ignored the situation.
That is except for one small detail.
Over the last few sessions, short-term treasuries have inverted in the 1-6 month range. Generally, we associate a yield curve inversion with a recession, but that's not the case here. This is just the one and two month treasuries having higher interest than six month treasuries.
In turn, this means the market expects there to be more demand for safe haven assets in the short term. This suggests that some serious money is starting to get ready for a protracted political battle over Federal funding.
Where are we going?
The underlying issue for the markets is the so-called "debt ceiling". In fact, it's taking on increased urgency because the Democrats are trying to tie it to a continuing resolution to fund the government after the budget runs out on September 30th.
The government wouldn't reach the debt ceiling
that quickly and it has measures to deal to get by for even longer. The issue
is the political brinkmanship of tying the two together, thus, there are two
competing bills in Congress.
There is ample coverage in the media over the political wrangling, so let's
look at the potential market implications.
If the government fails to pass a continuing resolution, it would "shut down", which largely has minor impacts on the market. Specifically, the last time there was a federal government shutdown, it was the longest in history up to that point. It came just before the markets hit the bottom of a correction in 2018, and the S&P 500 was up by 230 points, or around 10%, by the time it was over.
What's the big worry, then?
The debt ceiling could cause problems for the markets, though.
Despite political pundits talking about the US potentially defaulting on its debt, this is generally not remotely likely by any of the market participants. However, should Congress not agree to raise the debt ceiling, it would force the US government into "austerity".
How exactly that would play out is unknown
because it's never happened before. And, of course, markets don't like
uncertainty, hence the recent rise in yields.
The issue of how likely that is to happen depends on a political calculation. The
coming budget discussion will finance the government throughout the midterms,
meaning this is the time for both sides to make their case on fiscal policy.
Make hay while the sun shines
The Republicans are trying to make a case that the higher prices Americans are paying across the board come from increased government spending.
In fact, Republican strategists have pointed
out that price increases and fiscal spending are not only an issue that their
base is worried about but it's an increasing concern among independents too.
The fluctuation of opinion polls on the debt issue would likely be a driver of
how willing Republicans are to stick to their guns on the debt ceiling issue
and leverage it to curtain federal spending.
The two moderate Democrats have sided with slow-walking the latest stimulus bills. This suggest that the majority is slightly in favor of keeping a lid on spending.
The midterms and beyond
President Biden was the champion of increased spending, pushing for not only a higher budget, but the two spending bills that would add an additional $4.5T over the next ten years.
However, after the Afghanistan fiasco, and increasing discontent over the covid situation, the President's polling has turned negative.
With a higher unfavorable rating, it will be even harder for Biden to persuade his colleagues in Congress to push for higher spending. Meanwhile, the slipping poll numbers have emboldened Republicans, who see it as a winning strategy for the midterms.
Keeping things in line
Curtailing spending of a Democrat president is
a classic strategy of a Republican Congress. This suggests that the upcoming
debate on the budget could be the last change for any significant spending
until 2024, should Republicans prevail in the midterms.
Nevertheless, putting that into a trading strategy might be risky because it
depends on public perception of how important it is to maintain fiscal
prudence. And let's not forget, polls are notoriously fickle.
This article was submitted by Orbex.
