5 reasons Wall Street thinks the next fiscal feud will fizzle

Specialists Michael O'Connor, left, and Matthew Diez, foreground left, work with traders at the post that handles US Steel, on the floor of the New York Stock Exchange Thursday, Oct. 17, 2013. AP Photo/Richard Drew

(MoneyWatch) The short-term fiscal truce negotiated in Congress this week has raised fears that Americans may see only a brief reprieve from the political brinksmanship that closed the government and threatened an unprecedented U.S. debt default. Under this view, approaching deadlines to agree on a federal budget, renew the government's spending authority and lift the debt ceiling all but guarantee another bout of gridlock early next year.

Yet if Main Street is worried, Wall Street isn't. The emerging view among investors, stock analysts and economists is that the partisan rancor that continues to divide Washington, while bitter as ever, is less likely to trigger paralysis next time around. Of course, financial markets are often wrong and even outright delusional, as the housing bubble showed. But of late the Street has guessed -- correctly -- that lawmakers would avert disaster.

"Wall Street has been through this a few times now," said Jim O'Sullivan, chief U.S. economist with High Frequency Economics. He cited the 2011 debt limit fight, "fiscal cliff" clash last year and other political brawls that disrupted financial markets. "Each time there's talk of Armageddon, and each time it's been averted."

Congress faces three major budget deadlines in the coming months, with Democrats and Republicans already digging out their trenches. By Dec. 13, a House-Senate conference committee must agree on a budget resolution outlining federal tax, spending and debt levels. Next, by Jan. 15, 2014, Congress must extend the government's spending authority, currently set at $986 billion, or face a second round of sequester cuts. Finally, the debt limit that lawmakers just increased expires on Feb. 7, 2014, again raising the risk that the U.S. could default on its legal obligations for the first time.

Here are five reasons why the debate next time around may be less divisive and economically disruptive:

1. Expectations are low. The House-Senate conference committee charged with thrashing out a budget resolution is almost certain to fail. After all, Congress hasn't passed a budget since 2009, and Democrats and Republicans remain far apart in their respective fiscal priorities.

"In our view, a grand bargain is virtually impossible until either one party controls the government or there is a 180-degree turn in the way the two parties work together," Bank of America Merrill Lynch analyst Ethan Harris said in a note to clients.

While such a legislative failure may frustrate Americans and impede fiscal progress, investors already expect the budget talks to founder. That guards against any headline-induced swings in the stock market. And while sequester cuts of $20 billion will kick in if talks do collapse, they aren't expected to gravely wound the economy.

2. The people have spoken. According to public polling, large majorities of Americans disapproved of threats by lawmakers this month to shutter the government. With midterm electoral campaigns set to gear up, lawmakers in competitive races risk alienating voters in reprising such threats. Next year's debt-ceiling deadline bumps into election season, with primaries in some congressional districts starting in March. As a result, the proximity of these contests to the fiscal deadlines could cool the angry rhetoric that marked the latest debt crisis and even encourage the odd act of compromise.

3. Been there, haven't done that. The issue that sparked the latest fiscal battle -- the Affordable Care Act -- will have less force as a political rallying cry in 2014, when the landmark health law is fully implemented. Some hard-line conservatives will likely continue to try to weaken Obamacare, as the law is known, but top Republicans  concede that gutting the program is now out of the question. Opponents of the law are more likely to wage a drawn-out guerrilla war than engage in another politically costly frontal assault.

"We think Republican leaders are unlikely to allow an extreme outcome like a government shutdown or debt limit crisis over Obamacare changes again," said Goldman Sachs analyst Alec Phillips in a research note. 

4. Third time's a charm. Since November, Congress has raised the debt ceiling twice, both times without making large policy changes. Phillips said that precedent will make it hard for Republicans to demand major policy concessions when it is time to raise the borrowing cap next year.

5. The tax man cometh. The nominal deadline to raise the debt ceiling is Feb. 7, but analysts think the U.S. Treasury can deploy "extraordinary measures" to ensure that the U.S. can pay its debts for several months beyond that date. By then, tax revenue will have started replenishing the government's coffers, lowering the risk of default.

The federal deficit also is shrinking, and spending would fall further if the sequester cuts take effect. That conserves funds, further delaying the need to raise money. The government could gain more headroom under the ceiling if Fannie Mae and Freddie Mac, which pay special dividends to the Treasury every quarter, make a payment early next year, according to Goldman.

To be sure, the fiscal feuding will continue. And, while Wall Street remains confident about the outcome of these fiscal disputes, there is no certainty that the economy will escape unscathed. The partial government shutdown has reduced fourth-quarter economic growth by $24 billion, pushing down GDP by an annualized 0.6 percent, according to credit agency Standard & Poor's. Another spasm of factional infighting early next year would further erode the confidence of consumers and businesses.

The fiscal debate is sure to continue raging, but if market watchers are right, it may be with less ferocity.

  • Alain Sherter On Twitter»

    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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