Wall Street braces for volatility over congressional votes

The frantic sprint on Capitol Hill to prevent a government shutdown, avoid a debt default and pass trillions of dollars in infrastructure spending could make for a tumultuous week on Wall Street.

Congress is facing several critical deadlines jammed into a chaotic week with deep implications for the U.S economy. While the stock market has held strong as the pressure grows in Washington, investors may face a rude awakening — or an end-of-September surprise — as lawmakers navigate a fiscal obstacle course over the next few days.

Funding for the federal government expires on Thursday night and the push to avert a shutdown is tied to a partisan chicken fight over raising the federal debt limit. President Biden and Democratic leaders are also rushing to broker a truce between party progressives and moderates to move two massive infrastructure and social services bills by the end of the week.

The stock market has largely brushed off the building pressure in Washington, and investment experts are split over how much it may move in any given direction based on the progress of Biden’s agenda. But Wall Street veterans say the plethora of potential breakdowns and breakthroughs could mean a wild week for the market — particularly if investors wake up to the risk of a debt ceiling showdown.

“The climate in Washington is such that you cannot rule out the possibility of a standoff that ends with something really, really bad, and the market is not anticipating that,” said Scott Clemons, chief investment officer at Brown Brothers Harriman.

“We’ve seen this dance so many times. We’re accustomed to it being awkward but ending well,” he added. “The heightened tension in Washington is such that it’s a nonzero probability that something really goes wrong and is the source of substantial price volatility in the markets.”

Stocks have rallied fairly steadily since the beginning of the year as the recovery from the coronavirus recession accelerated with the help COVID-19 vaccines, steady stimulus and the release of pent-up demand. The market has held steady even as inflation hit decade-plus highs, the delta variant began weighing on the recovery and supply chains snarled across the world.

With the exception of a Sept. 20 selloff driven by concerns over Chinese real estate giant Evergrande, the market capped last week with four days of strong gains in what’s typically one of the weakest months for Wall Street.

Lindsey Bell, chief investment strategist at Ally Invest, said investors fared well despite last week’s rough start after weeks of rotating into stocks seen as safer bets in times of volatility, such as technology companies.

“People started flocking to those types of investments over the course of the last three or four weeks in preparation for this seasonally weak time,” she said. “Evergrande was kind of the straw that broke the camel’s back … and we saw the market hold up pretty well last week because the positioning was appropriate.”

But Washington’s frantic week could prompt more volatility as investors focus on the myriad implications of several different battles. Senate Republicans are all but certain to vote down a bill to extend government funding that’s paired with raising the debt ceiling, and what happens next is anyone’s guess.

Democrats are still crafting several key pillars of the multitrillion infrastructure and social services bill they’re aiming to pass this week, including the entire suite of tax hikes and changes meant to cover the cost of the legislation. It’s also unclear if Democrats will try to include a debt ceiling increase to that bill, which raises further questions about how and when the federal government will be funded starting Friday.

Speaker Nancy Pelosi (D) has scheduled a vote on the bipartisan infrastructure bill Thursday with hopes that a Democratic breakthrough on the larger package could send both pieces of legislation to Biden’s desk by the end of the week. But the president himself said Monday that the legislation may not be completed this week as Democrats scramble to find consensus.

“There is a long ‘to-do’ list in DC and any time spent on the debt limit is time not finalizing negotiations on other priorities,” wrote analysts with investment bank Raymond James in a research note.

“Democrats can use budget reconciliation to raise the debt limit, but that could be politically challenging, especially as they are battling against calls to lower their overall spending number in the $3.5 trillion bill.”

If Biden and congressional Democrats can thread the needle and make significant progress on their economic agenda, some investment experts think it could provide a modest boost to markets. While sturdy Federal Reserve and fiscal support for the economy helped put a floor under markets this year, Bell said the passage of even the bipartisan infrastructure bill could “add some wind to the sails of stocks.”

“The risk is more of the upside than the downside,” Bell said of the infrastructure push.

Experts don’t expect a brief government shutdown to weigh heavily on the market given the relatively limited economic impact of appropriations lapses. But several have warned that the stock market may be too optimistic about raising the debt ceiling amid the deep breakdown of trust between Democrats and Republicans.

Senate Republicans have insisted that Democrats must raise the debt ceiling on their own despite helping them run up the debt and are confident they will bear responsibility for a default. On Monday night, GOP senators blocked a House-passed short-term funding bill paired with a debt ceiling suspension.

Some GOP senators have touted the potential benefits of campaigning against Democrats in the wake of economic chaos and suggested that investors should not buy U.S. Treasury bonds because of the showdown.

“For a sitting U.S. senator to question the credit worthiness of US Treasuries, that’s a new one for me,” Clemons said. “When I listen to politicians talk about this so cavalierly … the markets are not anticipating this kind of prolonged dislocation.”

Investors may take serious losses if they’re caught off guard by the dysfunction, but the market’s reaction could play its own role in bridging the divide.

The Dow Jones Industrial Average suffered what was then its worst single-day loss by points in history in 2008 after House Republicans initially voted down legislation to establish the Troubled Asset Relief Program. The ensuing sell-off was one of several factors that helped salvage the bill and help rebuild the shattered banking system in the wake of the 2007-08 financial crisis.

“The lack of a market reaction could prolong the brinkmanship, as previous market pressure has been a forcing mechanism on Congress,” wrote the Raymond James analysts.