A fight in Washington over the debt ceiling looms, which could create market volatility

Published Tue, Nov 23 202112:10 PM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

Strategists expect Congress to pass a budget and raise the debt ceiling next month, but the path there could be a little bumpy for markets. The events in Washington are not expected to derail the year-end rally, but some strategists say investors should be aware that it may not be all smooth sailing, particularly if there is any kind of standoff in Congress. "Just given the concentration of uncertainty on Capitol Hill in the first half of December, there will be some headline volatility," said Isaac Boltansky, director of policy research at BTIG. " The federal government funding deadline is Dec. 3 . There's no real timetable on the Build Back Better legislation. The annual defense bill could have some back and forth... I do think there's a combination of political risk in the first half of December that will cause headline volatility." The House of Representatives Friday passed the $1.7 trillion social safety net and climate bill , and now the Build Back Better legislation moves to the Senate. Senate majority leader Charles Schumer would like to have a bill passed by Christmas, but it is likely to be modified and will face a struggle. The plan does not have Republican support and has been criticized for potentially adding to the trend of rising inflation. The legislation includes measures to expand Medicare with new hearing benefits . It also directs funding toward fighting climate change and lowers the cost of prescription drugs. Market focus already has been heavily on Washington, as investors awaited President Joe Biden's choice for Fed chairman. The president Monday selected Federal Reserve Chair Jerome Powell for a second term , sparking a relief rally that later tumbled as interest rates rose. Fed Governor Lael Brainard was named vice chair of the central bank . Strategists had expected more volatility if Brainard was named since she is viewed as more dovish. Now the spotlight is on Congress and how it handles the debt ceiling, the Build Back Better legislation and the budget. "I'm not losing sleep over it," Boltanksy said. "But now we also have a Fed chair confirmation to get through." Debt ceiling expiration date Treasury Secretary Janet Yellen said last week that the expiration date for the debt ceiling — that is, the earliest time the U.S. could face default — would be Dec. 15. Strategists expect it would be several more weeks, or even months, beyond that before the U.S. runs out of funds , but the ceiling debate should come to a head by mid-month. "Short-term funding markets are showing a little bit of stress, but there's not really a concern" among investors at this point, said Jeff Schulze, investment strategist at ClearBridge Investments. "Policymakers understand the importance of raising the debt ceiling. There may be some brinkmanship, but the debt ceiling gets raised... If we come down to the deadline, it certainly could create a little bit of volatility. Schulze added that the market is currently giving a high probability to the ceiling being raised. But policy strategists do not expect it to be a smooth path to the vote. The 1-month Treasury bill has been yielding more than the 3-month , which is not usually the case and could be a sign of some uncertainty around the debt ceiling expiration date. "At this point, the Democratic leadership in the Senate appears unwilling to use budget reconciliation to raise the debt ceiling and plans on allowing a crisis atmosphere that will either force Republicans to blink or Democratic senators to break the filibuster for the purpose of raising the debt ceiling," Cornerstone Macro's Andy Laperriere wrote in a recent note. "There is no sign the White House has a viable plan to prevent a default or a crisis environment," he noted. "The odds of a technical default, while still low, have never been higher and investors should expect market turbulence leading up to the X date." Reconciliation process as a possibility Under reconciliation , Democrats can pass legislation with a simple majority rather than the 60 votes normally required, but its use is limited. The Democrats have 50 seats in the Senate, and in the case of a tie, Vice President Kamala Harris could cast the deciding vote, giving them a majority. Boltansky of BTIG said the reconciliation process could be used, since Senate interpretation allows it to be used for revenues, spending and the debt limit, in a single bill or in separate bills. State Street's Michael Arone said the risk to the stock market at this point is still minimal. "As earnings season is basically complete, these things do take on greater importance," he said. Arone expects Congress will raise the debt ceiling before it's too late. "The question is how ugly is it going to get before they do. Who will blink first? Republicans are adamant that they are going to demand the Democrats use the reconciliation process. Expect that to go down to the wire. Expect that to be ugly," said Arone, chief investment strategist for State Street Global Advisors' U.S. SPDR business. Moody's Investors Service, in a recent report, said it expects Congress to raise the debt ceiling. The rating agency said if the ceiling were not raised and the U.S. missed an interest payment, it would downgrade the debt, currently rated AAA. Standard & Poor's downgraded the U.S. to AA+ in 2011 when Congress was squabbling over the debt ceiling.

The U.S. Capitol is seen on September 27, 2021 in Washington, DC as Congress returns today to a full schedule of pending legislative items.

Win McNamee | Getty Images

Strategists expect Congress to pass a budget and raise the debt ceiling next month, but the path there could be a little bumpy for markets.