The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.
When Congress returns to Washington on September 5 after its annual five-week August break, lawmakers will face a daunting pair of deadlines that are likely to have significant market ramifications in the weeks ahead.
Treasury Secretary Steven Mnuchin has asked Congress to raise the debt ceiling by September 29 to ensure the United States does not default on its debts for the first time in history. Congress also faces a September 30 deadline to approve government funding for fiscal year 2018, which begins on October 1. Without an agreement, a government shutdown would take place.
Given the political atmosphere in Washington, meeting these deadlines was already going to be difficult. But an additional layer of complexity has been added by the catastrophic devastation in Texas and Louisiana from Hurricane Harvey, which undoubtedly will necessitate a multi-billion-dollar emergency aid package from the federal government.
Here’s what investors should be watching for as a chaotic September unfolds in Washington:
Debt ceiling uncertainty is likely to affect markets
No policy issue in Washington has greater ability to affect the markets directly than the debt ceiling. In 2011, when Congress went to the very brink of default before approving a last-minute debt ceiling increase, key indexes saw declines of more than 10% on the uncertainty of whether Congress would act in time. One of the three major U.S. credit rating agencies downgraded U.S. debt from AAA, the highest rating, to AA+.
The debt ceiling places a cap on how much total debt the United States can accumulate. Congress suspended the debt ceiling for all of 2016, but it came back in March of this year at just below $20 trillion. Since then, the Treasury Department has employed so-called “extraordinary measures”—a series of steps to ensure the United States does not default. But those steps buy lawmakers only a temporary reprieve of a few months before they must act to increase the borrowing limit.
Mnuchin told Congress earlier this summer that he was authorizing the extraordinary measures only through September 29. He stopped short of saying the United States would run out of cash to pay its bills on that date, but it is widely believed this will occur in early October. Mnuchin is expected to announce the exact deadline in early September.
Last week, Senate Majority Leader Mitch McConnell (R-Ky.) said there was “no chance, zero chance” that Congress would fail to raise the debt ceiling in time. And House Speaker Paul Ryan (R-Wis.) said “I’m really not worried about getting this done.” But there is no timetable and no specific legislative plan for raising the debt ceiling.
In the past, conservatives on Capitol Hill have objected to “clean” debt ceiling increases, preferring instead to pair any increase with an equal amount of spending cuts. That has forced moderate Republicans to cobble together a fragile coalition with Democrats to raise the debt limit. Expect similar dynamics in September.
Ultimately, we believe Congress will raise the debt ceiling in time—it always has in the past. No one is really certain what the economic and market ramifications of default would be, and most members of Congress don’t really want to find out.
But investors should not be surprised if the debate goes right down to the wire, sparking significant market volatility.
Are government shutdown odds increasing?
At the same time as Congress wrestles with the debt ceiling, lawmakers will be engaged in a race to avert a government shutdown.
Each year, Congress is supposed to pass 12 appropriations bills that allocate funds for every government agency and program. Most years, they fail to do so by the October 1 start of the fiscal year. Given that Congress has passed exactly zero of the appropriations bills so far, there is no chance they will be able to do so in time.
As a result, Congress will need to resort to what it has done so many times in the recent past— approving a temporary measure, known as a “continuing resolution,” to keep the government open and operating. Reports from Capitol Hill indicate that a three-month extension, which would keep the government open through the end of 2017, is likely to be proposed. That would simply push off the debate until December.
But even a three-month extension of funding is no slam dunk. President Donald Trump has said he would support shutting down the government if Congress does not include funding for his proposed southern border wall.
That demand could provoke the highest-stakes confrontation between the White House and Congress since Trump took office. While the Republican majority in the House could pass a measure that includes border wall funding, there is little chance that such a bill could pass the Senate, where Republicans hold a slim 52-48 majority. Would the president really veto a bill that did not include border wall funding and shut down the government?
All of this uncertainty has triggered some analysts to raise the chance of a government shutdown to as high as 50-50.
From an investing standpoint, the market reaction to government shutdowns historically has been modest. But a government shutdown could be seen by the markets as another sign of failure from the Republican Congress and the White House, and more ammunition for the growing sense that the Trump administration and the Republican-controlled Congress are not going to be able to accomplish much legislatively.
There is no question that the market was anticipating a big year of legislative triumphs that would be good for the business community—health care reform, tax reform, perhaps an infrastructure spending package. Instead, Washington looks fractured and incompetent, and the likelihood of accomplishing much of anything is growing more remote. A government shutdown would be another illustration of the inability of the White House to work with Capitol Hill on a common vision.
Hurricane Harvey adds additional layer of complexity
The overwhelming devastation wrought by Hurricane Harvey will also come into play in congressional negotiations in the weeks ahead. Trump is expected to make a formal request for aid soon, and congressional leaders have indicated lawmakers will try to act fast.
One possible vehicle for the emergency aid package is the three-month extension of government funding. Attaching the aid to the continuing resolution could reduce the odds of a government shutdown, as it would be difficult for lawmakers or the president to oppose getting relief to devastated communities. But with the details of any government funding extension not expected until late September, Congress may act separately on the emergency measure in order to get support to hard-hit communities as fast as possible.
Emergency aid requests, however, are never controversy-free. Fiscal conservatives will again want to offset emergency spending with cuts from elsewhere in the budget. And there are old resentments at play. In early 2013, several prominent Texas lawmakers refused to support emergency aid to the East Coast after it was devastated by Hurricane Sandy.
After Hurricane Katrina devastated New Orleans in 2005, Congress quickly passed an initial aid package of $10 billion, and followed up weeks later with an additional $50 billion, after the full scope of the disaster was better understood. That’s an approach that could be used this time.
Regardless of how Congress proceeds, Hurricane Harvey added an entirely new dimension to the September drama in Washington.
Investors should hold steady amid uncertainty
How all of this will play out during coming weeks remains unclear. But investors should avoid overreacting to the news, particularly as the deadlines approach. Volatility is likely to increase as the markets weigh the actions—or inaction—of Washington. Investors should keep their focus on their long-term plans, and reach out to their financial consultants with any concerns or questions.
What You Can Do Next
If you’ve built a solid financial plan and a well-diversified portfolio, it’s best to ignore the political noise and focus on your long-term goals. Want to talk about your portfolio? Call our investment professionals at 800-355-2162.
Watch Schwab experts discuss other market and economic topics in the Schwab Market Snapshot.