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Debt ceiling fight creates 'heightened sense of urgency' on Wall Street

Don’t look now, but investors may have a new risk on the horizon: The U.S. debt ceiling.

The statutory limit caps the amount America can borrow — at least in theory — at just over $22 trillion — and must be raised to avoid default within the next few months.

Congress is scrambling to put together a vote to hike the ceiling ahead of its summer recess in August, and Treasury Secretary Steven Mnuchin recently warned that the government could run out of money as early as September.

Mnuchin has indicated a deal between the Trump administration and the Democrats who control the House of Representatives is close, but market observers aren’t nearly as sanguine.

While Deutsche Bank’s models suggest that October is the “base case” for when the Treasury will completely exhaust its funding, September 12-13 are seen as “high risk” dates.

Within the next two weeks, both the House of Representatives and the Senate depart Washington for summer recess. With lawmakers not reconvening until September 9, it compresses the timetable needed to strike a deal in a highly partisan atmosphere.

“In light of their schedule, there is a heightened sense of urgency for Congress to push through either a temporary stop-gap measure or a longer-term agreement some time in the next two weeks,” Deutsche Bank’s analysts said on Thursday.

‘A step into the unknown’

The last time the White House and Congress were controlled by opposing parties, a debt ceiling stalemate resulted in Standard & Poors stripping the U.S. of its AAA credit rating in 2001, the first time the world’s largest economy was ever downgraded.

According to Deutsche, the most likely scenario involves a temporary debt-limit suspension that would be followed by a last-minute deal in October. The best outcome, which is also perceived as highly unlikely given partisan discord, would be a “clean increase” next week.

“Lastly, an early September deal is the least likely (10%), as it requires Treasury’s cash balance to be near depletion by mid-September and lawmakers to work quickly as soon as they return from recess,” the bank added.

As both sides gird for a fight, the struggle could send Treasury yields, currently hunkered near historic lows, surging in knee-jerk response as investors bail on government debt.

“Reaching a bipartisan deal to raise the debt ceiling by early September should be a relatively straightforward exercise, but the increasingly confrontational relationship between President Donald Trump and House Democrats means that the odds of another crisis are rising,” Paul Ashworth, chief U.S. economist at Capital Economics, wrote in a note to clients on Thursday.

“A full-blown debt ceiling crisis would be a step into the unknown,” Ashworth said, adding that, “Given the dysfunctional and relationship between Trump and the House Democrats, we can’t rule out a failure to reach an agreement.”

‘Really scary’

Considering the mounting number of unknowns, a new fight over the government’s borrowing ability could prove calamitous, some analysts say.

The U.S. economy, while resilient, is projected to slow, while the U.S. and China are still embroiled in a trade war.

With a White House battered by controversy and Democrats who've publicly vowed to oppose the president, Wall Street fears the debt ceiling could become a new risk in a trading environment where there’s no shortage of them.

“Years ago, it would have been preposterous to think that we [would] actually have routine fights in this country about whether we're going to default or not,” Maya MacGuineas, president of the Committee for a Responsible Federal Budget, told Yahoo Finance this week.

“It's really scary,” she said, pronouncing herself “quite pessimistic” about the possibility of a debt deal. “It's something the financial markets should be completely concerned about.”

And in the background is the Federal Reserve, which is expected to mete out an interest rate cut later this month. The anticipated easing is seen as an “insurance policy” for the U.S., which is confronting economic headwinds and rising uncertainty.

Some economists have doubts about the efficacy of a rate cut — and a squabble over the debt limit could make matters worse.

“A rate cut will not offset tariffs and trade tensions, which are likely to intensify in the coming months. Neither will lower U.S. rates re-invigorate the stalled talks on the U.S. debt ceiling and spending caps,” said Marc C. Chandler, chief market strategist at Bannockburn Global Forex.

--Yahoo Finance’s Taylor Locke contributed to this article.

Javier is an editor for Yahoo Finance. Follow Javier on Twitter: @TeflonGeek

Read the latest financial and business news from Yahoo Finance

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