By Lewis Krauskopf
NEW YORK, Nov 5 (Reuters) - After Democrats seized control of the US Congress, investors are focused on the risk of standoffs over the government's borrowing limit, with the potential for political brinkmanship to unsettle markets.
Democrats wrested the Senate and House of Representatives away from President Donald Trump's Republican Party in Tuesday's midterm elections, prompting investors to consider the impact on the nation's finances and the next round of negotiations over the government's
debt limit.
Previous fights over the debt ceiling have led to down-to-the-wire showdowns as lawmakers use the cap on how much the US government can borrow as leverage over fiscal policy.
Fiscal worries have loomed over markets this year, weakening confidence in US Treasuries, as the national debt topped $40 trillion. In the wake of the election, analysts offered scenarios that could either exacerbate deficits or help constrain them.
DEFAULT UNLIKELY, BUT MARKETS MAY WORRY
The government is unlikely to hit the debt ceiling until late next year, but Democrats could wield the so-called X-date in budget or other negotiations with Republicans. Failure to raise the debt ceiling would threaten the ability of the Treasury to pay the government's debts.
"The Democrats are going to have some decent bargaining chips as it relates to the debt ceiling," said Michael Reynolds, vice president of investment strategy at Glenmede, a wealth-management firm.
"A default scenario from our view is very unlikely," Reynolds said. "But the further you go down that brinksmanship path, the more worried markets are going to be about that eventuality."
In the near term, analysts are zeroing in on December 11, the date by which Congress needs to reach agreement to fund the federal government. Analysts said Republicans could use that deadline as an opportunity to raise the debt ceiling before the Democratic-controlled Congress takes office in early January, but some were skeptical that would happen.
"The administration would probably like to get the debt ceiling raised in a lame-duck session, but I doubt that we'll see that now, given the scale of the Democrat victory," said Dustin Reid, chief fixed-income strategist at investment-management firm Mackenzie Financial in Toronto.
PROTRACTED STANDOFF POSSIBLE
If Congress fails to address the debt ceiling issue before year-end, Vail Hartman, US rates strategist at Canadian investment bank BMO, said in a note, "Financial markets could face a protracted debt ceiling standoff in 2027 – raising the risk of sovereign debt downgrades, price distortions around the projected X-date, and increased volatility in cash and repo markets should Treasury draw down its General Account to deploy extraordinary measures."
UBS analysts said in a note that as part of debt-ceiling negotiations Democrats could seek changes to Medicaid, housing incentives and other domestic priorities in exchange for their votes, with an agreement that might be stimulative and leave deficits wider than the baseline estimates of the nonpartisan Congressional Budget Office.
Some analysts said Democrats could put a check on Trump's spending or tax-cut aims.
"Divided government will make major fiscal legislation more difficult, particularly spending initiatives that lack bipartisan support," said Shawn Snyder, economic strategist at Potomac Fund Management.
In a report following the election, ratings agency Moody's said the broader US fiscal trajectory was unlikely to change materially, because the principal drivers of rising debt, including mandatory spending, demographic pressures and interest costs, remained in place.
Analysts at the BlackRock Investment Institute agreed that political gridlock was unlikely to alter the fiscal trajectory, but said in a note that "divided government raises the risk of funding standoffs and government shutdowns."
(Reporting by Lewis Krauskopf; Additional reporting by Suzanne McGee, Laura Matthews and Gertrude Chavez-Dreyfuss; Editing by Megan Davies and William Mallard)
