The results won’t be clear until Tuesday evening or possibly for days, but the outcome of the US midterm elections is poised to be an important event for financial markets.
With Republicans favored to take control of both houses of Congress, according to ABC News’ online election prediction site FiveThirtyEight, one of the biggest ramifications of such an outcome would be the chances of a renewed fight. on the debt ceiling. This is the legal limit on the amount of national debt the US Treasury can incur and if the cap is not raised in time, the US could theoretically default.
The Treasury could approach the debt limit of about $31.4 trillion in the current quarter, although economists note that “extraordinary” fiscal maneuvers would allow the government to avoid hitting the ceiling until some time in 2023.
Lily: Violating the US debt ceiling would be a ‘disaster’ for Americans, expert says, as potential showdown looms if Republicans win midterm
“The threat of a new debt ceiling is not just speculation,” said Deutsche Bank research analyst Henry Allen. “A number of senior Republicans have openly advocated using the debt ceiling as leverage with Democrats to extract policy concessions, as they did in 2011.”
The potential implications for financial markets of another fight over the debt ceiling “are still underestimated,” Allen wrote in a note Monday.
You have to go back more than a decade to see what happened during the last major debt ceiling showdown: based on the performance of the S&P 500 in 2011, the biggest fall of all he year ran from late July through August amid jitters that the United States could default, according to Deutsche Bank. The fall of the S&P 500 SPX,
was accompanied by a sharp decline in the Conference Board’s consumer confidence indicator, so the potential for future volatility this time around “is clear,” Allen said.
Source: Bloomberg, Deutsche Bank
Rather than restraining federal spending, the debt ceiling – if set below the level necessary to meet the government’s borrowing needs – theoretically endangers US confidence and credit by preventing the Treasury to pay government bills.
Lily: US Treasury plans to borrow $550 billion in fourth quarter
According to a Nov. 1 note from analyst Joseph Abate, Barclays expects the Treasury to begin using extraordinary measures and cash reserves in December. But Abate says both will likely be dry next September.
“We estimate that its current extraordinary measures give the Treasury an additional $350 billion in borrowing capacity above the limit,” Abate wrote. “Depending on how long the debt ceiling negotiations take in Congress, the Treasury may add to this total” through other actions.
For now, the most immediate impact on markets of a big Republican victory is that it could provide a short-term pop for stocks, according to Morgan Stanley chief equity strategist Mike Wilson. Although he remains long-term bearish for stocks, Wilson has an upside target in the 4,000-4,150 range for the S&P 500, which was trading around 3,836 on Tuesday morning.
Democrats currently hold a narrow majority in the House and control the Senate thanks to Vice President Kamala Harris’ decisive vote. Republicans would “probably throw a wrench in the aggressive fiscal spending plans that Democrats would always like to see done,” Wilson said. Thus, a Republican takeover of at least one house of Congress has the potential to boost the appeal of long-term Treasuries and depress yields, which move in the opposite direction of prices.
On Tuesday morning, the three main stock indices DJIA,
COMP,
were heading higher, extending the gains seen on Monday and Friday. Meanwhile, most treasury yields, with the exception of yields on 3-month and 6-month bills, were lower – driven by a drop in the 7-year yield TMUBMUSD07Y,
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