NEW YORK — The clock is ticking, and political risk tied to U.S. debt woes is rising, causing Wall Street to wonder if a "Beltway bombshell" could result in a market shock.
Congress is again involved in a public spat about the nation's finances. The fight harkens back to the "fiscal cliff" debate in December that caused market volatility to spike and the contentious battle about raising the debt ceiling in the summer of 2011, which sparked a stock sell-off.
Investors are nervous because the outcome, of what Oppenheimer Funds dubs "Capitol Games," remains uncertain and tough to handicap.
"There is this tail risk that our politicians are willing to play with fire," says Brian Levitt, senior economist at OppenheimerFunds. "If you get a bad political outcome, you could have a meaningful correction in the stock market."
The political posturing is raising the specter of a federal government shutdown on Oct. 1. It's also boosting fears that in mid-October, the USA might not have enough cash to pay its bills, which could result in its first-ever default. To avoid these bad outcomes and negative market surprises, lawmakers must soon strike deals to keep funding the government and raise the nation's $16.7 trillion debt ceiling.
For now, Wall Street is calm. The base case is that an 11th-hour deal between Democrats and Republicans gets done.
"The likelihood of the U.S. defaulting on its debt is remote," says Andrew Busch, editor of The Busch Update.
There have been few signs of a "major market disruption," just a sense of "caution" on the part of investors, says Craig Johnson, technical market strategist at Piper Jaffray.
While the Dow Jones industrial average just posted its first five-session losing streak for the first time since August, after Thursday's rebound it's down just 2.2% from its Sept. 18 record close. Johnson expects stocks to rebound once the political uncertainty lifts, just as they did in early January, when the fiscal cliff was averted.
A big reason investors don't fear the worst, Busch says, is because politicians won't want to take the blame for harming the nation's economy, credit rating or markets. The bad memories of August 2011, when an extended fight about the debt ceiling caused the U.S. to lose its triple-A credit rating and the Dow to fall 635 points in one day, are still fresh.
"No one wants to go through that again," Busch says.
Still, a "Beltway bombshell" can't be ruled out, and investors should brace for more big market swings, warns Kristina Hooper, U.S. investment strategist at Allianz Global Investors.
While most analysts say a default would be more damaging to markets, Hooper says a shutdown, even a short one, will hurt investors' psyche. Given that the Oct. 1 timing of a government shutdown comes before the debt-ceiling showdown later in October, a shutdown would boost fears that a default is more likely.
"There is the potential for confidence erosion and an out-sized market reaction if we see a government shutdown," says Hooper.