Global Weekly Commentary: Debt ceiling spat takes a breather
A low risk of default
We believe the debt ceiling dispute will eventually resolve but could trigger more volatility. The broadening economic restart keeps us tactically pro-risk.
U.S. job growth slowed sharply in September, but we see it as unlikely to affect the Fed’s taper plan. The Senate reached a deal on a temporary debt ceiling rise.
U.S. inflation data will be in focus as price pressure has appeared to be more persistent than expected and broadened beyond pandemic-related items.
We still see a low risk of technical default by the U.S. and expect the debt ceiling debacle to ultimately resolve. The broadening economic restart keeps us tactically pro-risk, yet we see a narrowing path for risk assets to push higher and markets more prone to temporary pullbacks. Key events toward the year end, including the lapse of the temporary debt ceiling rise, could potentially trigger market volatility. We favor looking through market jitters against the backdrop of the restart.
Search for the debt ceiling
Google searches using the key phrase “debt ceiling,” 2009-2021
Sources: BlackRock Investment Institute, with data from Google, October 2021. Notes: Interest over time shows search interest relative to the highest point on the chart for the given time, according to Google. A value of 100 is the peak popularity for the term. A value of 50 means that the term is half as popular. A score of zero means there was not enough data for this term.
The showdown around the debt ceiling – a self-imposed federal borrowing limit - has kept investors on their toes. The debt ceiling has become a subject of intense partisan wrangling over recent decades, with negotiations going down the wire in 2011 and 2013. Google searches on the key phrase “debt ceiling” have surged to the highest level since the 2013. See the chart above. In recent months the impasse has led to market jitters, especially after risk assets have had an extended run higher. The front end of Treasury yield curve – a popular gauge of market sentiment on the issue – had shot up until the Senate struck a deal to temporarily raise the debt ceiling last week. Yet there is more political squabble to come toward the year end. The U.S. government could once again near a technical default around the time when the temporary government funding is set to lapse if Congress fails to approve new spending legislation and raise the debt ceiling. Democrats have yet to unify behind their multi-trillion-dollar spending plans on infrastructure, social policy and climate change.
The temporary debt ceiling increase will likely allow the Democratic Party to focus on rallying its members in Congress around the spending plans – key legislative priorities ahead of the 2022 midterm elections. As expected, the $3.5 trillion price tag of the bill on social policy and climate change is being scaled down to help ensure the support of party moderates.
A smaller package means a reduced amount of revenue needed to offset spending. The tax proposals from the House Ways and Means Committee prior to the latest effort among Democrats to scale down the plan already showed moderated tax increases. This includes a proposed rise in the corporate tax rate to 26.5%, down from 28% in the original proposal. It also showed an increase in the Global Intangible Low Tax Income (GILTI) tax – intended to discourage corporations from moving profits overseas – to 16.5%, down from 21%. This increase would be line with the new global minimum tax agreement that aims to achieve the same goal. We are tactically neutral U.S. equities as we see large caps as exposed to risks of higher taxes and tighter regulation. The tax increases will likely have the largest impact on financials and communication services, in our view, but any further watering down of the proposed tax increases would reduce the headwind for these sectors.
The debt ceiling debate recently has triggered headlines and volatility, and we believe markets generally are increasingly susceptible to swings in sentiment. This includes supply-driven price spikes in energy and other prices awaking fears of runaway inflation and central bank actions to suppress it. We see the price spikes as mostly related to the powerful economic restart and therefore not permanent, but recognize inflation narratives can easily take hold of markets.
The bottom line: We continue to see a low risk of a technical default by the U.S. government, and expect a downsized spending package and related tax increases. The debt ceiling showdown may return in December, yet we believe it will ultimately be resolved and prefer to look through potential market volatility. Political brinkmanship could lead to a short-lived government shutdown and reignite concerns of a technical default. We are tactically neutral U.S. equities as we see U.S. growth momentum peaking and expect other regions to benefit more from the broadening economic restart. We are strongly underweight U.S. Treasuries as we see a gradual rise in nominal yields even with the Fed poised to start tapering by the end of the year. We are tactically pro-risk, yet recognize the path for further gains in risk assets has narrowed after an extended run higher and that markets have become more susceptible to sentiment swings.
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