Debt-ceiling drama could cause serious volatility ahead

Here's what will happen if we hit the debt ceiling

The chance of a government shutdown in the fall, should Congress fail to reach an agreement around the debt ceiling, may cause a surge in market volatility ahead.

While strategists and economists largely argue that the government is likely to avoid a shutdown, as the debt limit is a perennial issue, such a shutdown would cause a spike in the CBOE volatility index and depress the value of the yield on the 10-year Treasury note, according to Gina Sanchez, CEO of Chantico Global.

Her working assumption is that Congress will, in fact, raise the debt limit in time to avoid defaulting, Sanchez said Thursday on CNBC's "Trading Nation." However, she added, "If recent Washington drama is the new normal, then we might see heightened volatility in early October." Such market volatility would likely be short-lived, as much of it has been this year.

Sanchez said a look at Federal Open Market Committee transcripts from August 2011, around the time that the U.S. government narrowly avoided a shutdown by agreeing to raise the debt limit, gives clues as to how the government would prioritize cash in the event of a shutdown.

"The Treasury would likely prioritize interest payments over other federal obligations. However, even a brief interruption in government payments could be very disruptive," she said.

For example, she said, as many as 800,000 nonessential government workers would be put on leave, and other services such as national parks would close; in turn, growth would take a "significant hit." Furthermore, if the government does freeze, earnings could see a meaningful downward revision for next year.

In 2011, a highly dramatic debt-ceiling "crisis," in which Congress failed to raise the debt ceiling until it seemed to become immediately necessary, led Standard & Poor's to downgrade the credit rating of the United States and generated considerable market volatility.

However, that year as well as in a similar situation in 2013, Congress eventually agreed that the government could indeed borrow more money.

This time around, some say the impact of debt-ceiling jitters has already appeared evident in equity and currency markets.

In a Thursday interview with CNBC, hours after President Donald Trump tweeted about the debt-ceiling situation being a "mess," House Speaker Paul Ryan said the debt ceiling would be raised.

Some say the prospect of a federal shutdown would likely mean naught for stocks.

Most shutdowns "don't last long and equities rarely see a large sell-off," wrote Ryan Detrick, senior market strategist at LPL Financial in a report on Thursday.

According to his analysis, the longest shutdown since 1976 lasted 21 days, between late 1995 and early 1996, and the S&P 500's return was 0.1 percent.