The debt ceiling fight dictates the stock market. Why could that change so quickly.

However, there is no deal. However, Wall Street doesn’t seem to be confused at all – or at least not that much. Perhaps it is because the market is anticipating that all the talking in Washington – the White House and Congress have been assembling every now and then over the past couple of weeks – will pay off.

But investors beware. Even an 11-hour agreement can cause more than a few anxious moments, and even a little sadness.

But before we go there, first a summary of how bad the default is. The stock market will almost certainly go down, pulling down retirement account values. Social Security and other government benefits that millions of Americans depend on will cease. There will undoubtedly be irreparable damage to global confidence in the US economic system.

As of late Monday afternoon, President Joe Biden and House Speaker Kevin McCarthy were still trying to agree on how to pay the bills. Earlier in the day, JPMorgan’s Dubrovko Lacos-Pojas sounded the alarm about how ugly things would be if there wasn’t a meeting of minds. He wrote that the country is approaching a “financial Rubicon” and that this informal stance of investors could lead to a “significant repricing of shares” if the government defaults.

By contrast, debt markets have been much more sensitive. Treasury bill for one month
And

That extends through the deadline, it is trading at a record high of 5.718%, surpassing the high of 5.633% hit on May 12th. The yield rose 0.239 percentage points, which is the largest one-day gain since May 5, which indicates that investors are asking for an increase. Pay compensation for what they see as increased risk.

Perhaps the most stomach-soaking takeaway from Lacos-Pojas, though, are his thoughts on what can happen to the stock market, no matter what the deal. He wrote that “controversies as divisive as the 2011 default should serve as cautionary tales to ignore the stock market and then violently reprice the risk of default in the United States.” Twelve years ago, the

Standard & Poor’s 500

It fell about 17% in a key two weeks near the default deadline.

There are key differences between now and 2011. Today, monetary policy is tightening, the money supply is collapsing, inflation is higher, and stock valuations are richer. Because of these changes, a default on the part of the government will increase the likelihood that risky assets will be sold.

The deal does not guarantee smooth sailing, Lacos Pogas wrote. He predicted that there would be more instability in the market than the price appears now, and warned that he expects any deal to “negatively affect federal spending and the contentious budget negotiation process later this year.”

In addition, the fact that raising the debt ceiling could be more of a short-term solution means that the country may have to endure another round of negotiations next year — all with the same obstacles, and added pressure from the president. election.

He wrote that this leaves the market with two big concerns.

The first is that there is “the potential for a risk-off move in equities as we approach the expected x date in early June without a widely supported solution.” In other words, the market may suddenly wake up to the risk all at once as time runs out, resulting in huge losses.

The second is that there could be cuts in federal spending to some key priorities of the Biden administration as a result of a comprehensive debt ceiling agreement, or federal budget negotiations in the fall.

To hedge the risk of market volatility around the approaching deadline, Lakos-Bujas recommends spread buying—a strategy in which investors buy and sell two call options at different prices simultaneously, limiting losses—on

Cboe volatility indicator

(ix). In terms of positioning themselves ahead of potential changes in government spending, he recommends reducing stock ownership with exposure to environmental/climate changes, and electric vehicles.

While playing with fire is nothing new for politicians, it is worth remembering that this particular tactic is.

“The intense politicization of the debt ceiling was a relatively recent development that began in 2011, which also happened to be the most controversial debt ceiling hike in recent history, which ultimately ended with a downgrade of the United States’ sovereign credit rating by Standard & Poor’s,” wrote-Pojas.

Death and taxes may have always been inevitable, but this kind of political debate was not.

Write to Teresa Rivas at [email protected]