Debt Ceiling Debate Takes Center Stage as Government Shutdown Continues

Key points

  • It appears likely the first government shutdown since 1996 will not be resolved quickly.
  • We believe Congress will seek to package reopening the government with a debt ceiling increase.
  • Despite the brinksmanship, we don't expect to see a downgrade of U.S. government debt by the major ratings agencies.

Just a few days into the first government shutdown since 1996, it appears likely the shutdown will not be resolved quickly. We think Congress will seek to package reopening the government with a debt ceiling increase.

Prior to the October 1 deadline for passage of an agreement to fund government operations, the House of Representatives passed a series of temporary measures to keep the government operating through December 15. But House members attached a series of provisions to defund or delay all or parts of the Affordable Care Act, the new health care law. The Democrat-controlled Senate rejected each of those bills.

The next step in the House is to approve a series of bills that temporarily fund specific parts of the government—such as ensuring veterans' benefits are paid and reopening national parks and monuments. But the Senate is unlikely to support a piecemeal effort. Democrats in the Senate and the president have consistently said that they will support only a "clean" continuing resolution that reopens the government.

Talks are ongoing, and included an October 2 meeting at the White House between the President and Congressional leaders of both parties that news reports called cordial but unproductive. While anything is possible, we think an abrupt change in stance by either party is unlikely.

Debt ceiling debate now looming even larger

We think there is an increasing likelihood that the government shutdown and the impending debate over increasing the debt ceiling will come together.

The U.S. government hit the current debt ceiling of $16.7 trillion in May. Since then, the Treasury Department has been using "extraordinary measures" to avoid defaulting on the country's debts. Treasury Secretary Jacob Lew recently said the government will be nearly out of available cash by October 17, and that has become the new target date for getting a debt ceiling increase passed. There may be some wiggle room, but it appears certain that Congress will have to increase the debt ceiling within a few days of October 17.

President Obama has said repeatedly that he will not negotiate on the debt ceiling and that he will only sign a clean bill that does not contain other items. But with the government shut down, and the debt ceiling deadline two to three weeks away, House Republicans are now discussing merging the two issues so that a single agreement can be negotiated. They feel they have more leverage on the debt ceiling because failing to increase it and defaulting on our debts has much larger ramifications for the markets and the economy than the government shutdown has alone. They want to push for a larger agreement that reopens the government, increases the debt ceiling, and addresses longer-term budget issues, including some entitlement reforms and a framework for tax reform—a complicated negotiation to complete in the limited time available. It remains to be seen whether Democrats will engage in negotiations over a larger agreement.

Despite the brinksmanship, we don't expect a downgrade of U.S. government debt by the major ratings agencies. The U.S. is not on negative outlook and Moody's has indicated that it doesn't expect to change their ratings on U.S. debt even in the event of a shutdown over the debt ceiling. S&P hasn't said much of anything yet, but it seems that it will hold off after downgrading the U.S. two years ago. Fitch has the U.S. at AAA, so it could move to downgrade, but there is no indication that it is moving in that direction.

The U.S. government hit the current debt ceiling of $16.7 trillion in May. Since then, the Treasury Department has been using what it calls "extraordinary measures" to avoid defaulting on the country's debts. Last week, Treasury Secretary Jacob Lew updated Congress with a letter that said the government will be nearly out of available cash by October 17. That date has become the new target for getting a debt ceiling increase passed through Congress.

Absent a default or a downgrade, the other issue for the markets will be lack of information. The Bureau of Labor Statistics, along with other nonessential agencies, will not be working full time, if at all. That means less data collection and aggregation. The all-important unemployment report scheduled for Friday will not be released. The surveys have been taken, but the aggregation of the data takes place the week that the report is released, so it could be delayed. Other economic reports would also be delayed, which means an information vacuum for the markets.

In this case, no news is definitely not good news.

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