The stock market sold off on Wednesday because of the threat President Trump made in his speech on Tuesday to shut the government down if he didn’t get funding for the southern border wall. This is in direct conflict with the Treasury Department which is asking Congress to raise the debt ceiling. Usually presidents are in favor of raising the debt ceiling, but President Trump wants to use it as leverage to get what he wants. The biggest problem with this tactic is it adds another faction to the already contentious debate. Normally, there are two main factions: those who want to raise the ceiling cleanly, meaning with no legislative add-on and those who want to add spending cuts to the increase. This is sort of like the opposite of pork. Pork is special spending deals to get a bill approved.
The reason President Trump’s tactic might be seen as potentially dangerous is because funding the wall is an increase in spending. The President has been asking for $33 billion in new funds for defense and border security with $1.6 billion for the wall. Now you have 3 factions, two of which are willing to shut the government down to get what they want. The American people see shutting the government down negatively because it shows a stubborn lack of an ability to compromise. I still think the debt ceiling will be raised, but this new tactic makes the process potentially more stressful for the markets. The debt ceiling issue is like the tax cut issue; if the Republicans don’t get something done, they may lose the 2018 election. The best part about the debt ceiling is there’s no consequences unlike tax cuts which potentially lower government revenue. The debt ceiling is an arbitrary limit which is meaningless. It would make more sense to look at the debt to GDP ratio as I have discussed previously.
The result of the risk surrounding the debt ceiling is causing bonds due in October to have higher yields than they normally would. You may ask the obvious question which is why the stock market would fall if everyone knows the debt ceiling will be raised. The answer is the potential for a debt rating downgrade and the chance that an elongated government shutdown would negatively impact business activity as many federal employees would be put out of work. The Treasury curve adequately depicts these risks with a higher yield. The stock market has almost no chance of crashing 60% because of a default, but a 5%-10% correction is possible the longer it goes on for the reasons I just mentioned. This is the same reason why stocks go down on the threat of nuclear war. No one thinks there will be a nuclear war, but a 1% chance of a war should send stocks lower by almost 1%.
