Investors: Stay calm regarding debt ceiling wrangling

As Congress grapples to reach a deal to either lift or suspend the federal debt ceiling, the message within the institutional investment industry is to keep calm and carry on.

"On one hand, everybody says (raising the debt ceiling) is a big deal that must be done," said Simona Mocuta, senior economist at State Street Global Advisors. "And yet, nobody really believes it's a genuine risk because there seems to be a substantial expectation that this will get done. I think I agree with that; the consequences are too dire to deal with (otherwise)."

Ms. Mocuta added: "As complicated as everything looks over the next couple of weeks, this is the one thing I would be shocked (if we didn't do). I can't imagine us not doing this."

Speaking at a Senate Banking Committee hearing on Sept. 28, Treasury Secretary Janet L. Yellen said that if Congress does not address the debt limit by Oct. 18, then the Treasury would likely "be left with very limited resources that would be depleted quickly," and described such an event as "catastrophic."

"The full faith and credit of the United States would be impaired and our country would likely face a financial crisis and economic recession as a result," Ms. Yellen stated during her testimony, adding that "the debt ceiling has been raised or suspended 78 times since 1960."

But "Keep Calm and Carry On" was the phrase that PIMCO's managing director and head of public policy Libby Cantrill used to title her latest "Washington Watch" column.

In her Sept. 22 column, Ms. Cantrill wrote that since Senate Minority Leader Mitch McConnell, R-Ky., has indicated zero Republican support for raising the debt ceiling, Democrats will likely "be forced to reopen and amend the budget reconciliation instructions and pass the debt ceiling increase alone but getting there will take some time and could start being reflected in the markets (although it has barely registered as of now)."

"Legislating is not easy, and what we are seeing now, while certainly in more public view than what a lot in Democratic leadership would prefer to see, is all pretty predictable," Ms. Cantrill wrote.

In a commentary from the BlackRock Investment Institute published Sept. 20 titled, "Debt ceiling showdown redux," authors Jean Boivin, head of the institute; Wei Li, global chief investment strategist; Kurt Reiman, senior strategist for North America; and Nicholas Fawcett, member of BII's economic and markets research team, wrote that they "remain pro risk and opt to look through any short-lived volatility that could result from a battle over lifting the U.S. debt limit and funding the government."

"We don't see fundamental risks from the debt ceiling showdown with a low risk of technical default and limited chance of a temporary government shutdown," BlackRock's commentary stated, before adding: "We believe Congress will ultimately reach an agreement to raise or extend the debt limit, but likely not until right before the Treasury exhausts its borrowing capacity."

Anthony Brown, a partner and U.S. director of capital markets for Mercer LLC's U.S. wealth business, said in an email that Mercer is "not advising institutional investors take any action."

"There's almost no chance that the government will default, and a short-term government shutdown would not have a lasting impact," Mr. Brown added.

Meanwhile, Carlton W. Lenoir Sr., executive director of the Chicago Public School Teachers' Pension and Retirement Fund, wrote in an email that while the $13.1 billion pension plan always remains "cognizant and vigilant when it comes to current events impacting the markets," the retirement fund, like all institutional investors, is a long-term investor.

"As an institutional investor, it's important to remember that we are not market traders or timers — we are long-term investors with an infinite horizon," Mr. Lenoir said. "We set an asset allocation policy that allows us to ride out market volatility and we remain confident in our manager selection, mix between public and private assets, and long-term focus."

But while observers think an actual default is unlikely, the perception of brinkmanship could destabilize markets. So far, reaction is muted: Market participants attribute at least part of this month's rise in the 1-month Treasury bill yield to the debt ceiling standoff. Since the start of September, the rate has increased to 0.07% from 0.04%. During that period, the 3-month yield has dropped to 0.04% from 0.05%, while the 6-month yield is flat at 0.06%.

"With every additional day that goes by without clarity you'll get more sense of unease in the market, particularly in global markets," SSGA's Ms. Mocuta said. "I think you're still in this period where you still have time, so you're probably not going to see it yet. It's probably going to need to get to the brink."

Of course, this isn't the first time in recent history that Congress has faced a standoff over the debt ceiling. In 2013, political brinkmanship over defunding the Affordable Care Act resulted in the U.S. government shutting down for 16 days.

Before that, in 2011, a delayed agreement to raise the debt limit led to a downgrade of America's credit rating — a first for the U.S.

Short-term yields also spiked during the 2011 debt ceiling battle, which helped trigger S&P downgrading the U.S. government's debt to AA+ from AAA. The 1-month and 3-month T-bill yields spiked to 0.13% and 0.10% in early August, compared to the prior month's 0.01% and 0.02%, respectively. After the Obama administration and Congress reached an agreement, the yields settled back down to prior levels.

Added Ms. Mocuta: "We're all watching this quite closely. It's quite tiresome to be in the same place every few years, but here we are again," Ms. Mocuta added.

Bloomberg and P&I Data Editor Larry Rothman contributed.