Kevin McCarthy’s unprecedented ouster from the presidency of the US House of Representatives last week sparked understandable concern among investors and market analysts, who saw even more signs of political dysfunction in the US.
Ultimately, the move — the result of a vote forced by a handful of far-right lawmakers from his own Republican Party — came after McCarthy managed to avert a government shutdown last weekend. In the eyes of the rebels, his fatal sin was colluding with the Democrats to make a deal. House Democrats, meanwhile, were not inclined to offer McCarthy a lifeline.
Investors argued that the political chaos was not the cause of the bond sell-off that drove long-term Treasury yields to 16-year highs and sent stocks to their lowest levels since early June, but rather that it was part of a troubling and long-term trend crisis was seen. Running pattern.
“We do not expect this specific event to destabilize markets, but the dysfunction in Washington could contribute to eroding confidence in U.S. exceptionalism,” Carl Ludwigson, managing director of Bel Air Investment Advisers, said in a note .
The yield on the 30-year Treasury note BX:TMUBMUSD30Y rose 23.2 basis points last week to reach 4.941% on Friday, the highest since September 20, 2007. The yield on the 10-year Treasury note BX:TMUBMUSD10Y exceeded 4.941% on the 4th. October 4.80%. 3, the highest since August 8, 2007, and ended the week at 4.783%.
Market participants focused on Friday on a much stronger-than-expected U.S. jobs report for September. Shares initially plunged but then rebounded to end the session with solid gains. The bounce saw the S&P 500 index SPX turn the week into positive territory with a gain of 0.5%, breaking a streak of four consecutive weekly declines, while the Dow Jones Industrial Average DJIA extended its weekly decline to 0.3 % and the Nasdaq Composite COMP increased by 1.6%.
Read: US stocks experience a surprising rally on Friday. But can the party last?
Undoubtedly, investors will be largely focused on inflation data in the coming week as they try to gauge the Federal Reserve’s likely interest rate path. The September consumer price index is due on Thursday, a day after investors get a glimpse of wholesale price pressures via the September producer price index.
But the coming week also promises more political drama as divided Republicans in the House of Representatives try to choose McCarthy’s successor. Given McCarthy’s fate, it is expected that this successor will have less chance of walking down the aisle. Oddsmakers now see an increased risk of a government shutdown when the emergency funding measure expires next month.
Removing McCarthy without a clear successor and with the threat of another shutdown adds to greater uncertainty about the process of maintaining a functioning government at a time of increasing market volatility, particularly interest rate volatility, Ludwigson said.
See: Kevin McCarthy ousted as House Speaker: Here’s who could replace him
This all follows the debt ceiling dispute in Congress earlier this year, in which the US narrowly averted a default for the first time ever. That fight led Fitch Ratings in August to downgrade the U.S. government’s AAA credit rating to AA+, citing erosion of governance over the past two decades.
An earlier dispute over the debt ceiling led S&P Global to withdraw its AAA rating from the United States in 2011. Analysts fear that a shutdown in November could result in Moody’s Investors Service becoming the last of the three major ratings firms to withdraw its top rating.
Also read: Wall Street fears the U.S. could lose its last AAA credit rating as political chaos fuels fears of a government shutdown
Others see much higher stakes. Billionaire investor Ray Dalio argued in a LinkedIn post Friday that McCarthy’s removal was a sign of increasing political polarization and “another step away from democracy and toward civil war.”
For the financial markets, the problems of US governance remain largely in the background – and are probably not an everyday issue for investors.
“It is a problem, and it is a big problem, but it is not a new problem, so it is difficult to connect the meta-problems that have been building not for months or years, but actually for decades, to the current market dynamics said Christopher Smart, founder and managing partner of Arbroath Group, a consultancy.
Mark Rosenberg, co-founder of risk analytics firm GeoQuant, now part of Fitch, told MarketWatch that the U.S. is increasingly taking on some of the characteristics of an emerging market country, “where governance risk related to elections is increasing,” creating uncertainty around fundamental political issues Government direction.
Of course, the US is not on the same level as emerging markets, he said. After all, government bonds remain the largest and most liquid financial market in the world. US assets are not affected to the same extent as emerging market assets.
But an implicit backdrop of political dysfunction “increases the uncertainty that investors attribute to different economic data, likely making these selloffs more extreme and volatile than they would have been in these less predictable political patterns,” he said.
GeoQuant has found a correlation over time between its measure of governance risk and the yield of the 30-year Treasury bond BX:TMUBMUSD30Y (see chart below).
The US is not the only developed market experiencing increased dysfunction. A sell-off in British government bonds, known as gilts, that sent shockwaves through financial markets last year, forcing the Bank of England to intervene and leading to the resignation of Prime Minister Liz Truss, was a “clear expression” of the phenomenon, Rosenberg said.
The “mini-budget” presented last autumn by Truss and her finance minister Kwasi Kwarteng promised large, unfunded tax cuts. Recognizing the need for more debt to finance the tax cuts and the likelihood that a resulting increase in consumer spending could force the central bank to raise interest rates further, bond investors began selling government bonds, driving yields significantly higher. This caused massive pain to pension funds, threatened the financial system, prompted the BOE to act and forced the government to do a U-turn.
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This is a textbook dynamic for emerging markets, said Weinberg: “A change in policy, and then investors bluff this change.” It is similar to what investors in emerging markets like Brazil, Poland or Turkey are used to.
“I don’t think the U.S. is there yet,” he said, but a selloff of long-dated U.S. debt coupled with worries about rising debt burdens and political dysfunction over fiscal matters is eye-opening.