The fiscal year for the U.S. Government ends September 30th, 2017. Which is something market participants could care less about if not for, sometime near that date, Congress needs to raise the debt ceiling. Missing that deadline would result in a self-inflicted financial wound that would send shock-waves throughout global markets.  The U.S. Government has been paying off debt since the Andrew Jackson administration without missing a single payment. Raising the debt ceiling is a routine vote.

In fact, with the polarized Washington we have seen in recent years, it is happening a lot more frequently, as Congress has only once passed a budget in the past eight years. In lieu of a budget, Congress passes what is known as a continuing resolution.  A continuing resolution is a type of legislation in which Congress decides to let last year’s budget continue as this year’s budget. Nevertheless, a continuing resolution is incomplete, as it does not allow for the government to spend the money allocated in the continuing resolution, without raising the debt ceiling.  To ultimately raise the debt ceiling, the government needs to pass a specific bill to do so. Historically, this has been unanimously agreed upon, until in 2010 when the Tea Party took over Congress, on the promises of lowering taxes and limiting government spending.

Inside the Tea Party, there was an even more strident faction, and the group then became known as the Freedom Caucus.  As their power grew, the Freedom Caucus decided the debt ceiling was the perfect place for them to make a political statement. They did so in 2011, holding up the debt ceiling until the midnight hour. This led to the debt rating agency, S&P Global Ratings, to downgrade U.S. Government debt for the first time in history on Friday, August 5, 2011. The very next trading day, Monday, August 8, 2011, the Dow Jones fell 635 points and the VIX rose from 32 to 48. Ultimately, the debt ceiling was signed, but without the support of the Freedom Caucus.

“I would be embarrassed to tell you how many folks ran saying that they weren’t going to spend a bunch of money, they weren’t going to raise the debt ceiling, and then they went to Washington, D.C., and did exactly that.”
Mick Mulvaney (Freedom Caucus Founding Member)

The Freedom Caucus continues to oppose raising the debt ceiling without a budget reducing spending. Unless there is some sort of miracle budget deal agreed to before September 30th of this year, there are only two options: raise the debt ceiling, or fall off the fiscal cliff. Prior to the August recess, Senate Majority Leader Mitch McConnell has stated that the Senate will work on a tax reform bill, which will leave just 12 days of governing after the August recess to raise the debt ceiling.

Under normal circumstances, this should be done easily, but many investors are beginning to wonder if we indeed are in normal circumstances. The White House position is not entirely clear. White House Press Secretary Sarah Huckabee Sanders stated the White House position is the same as Treasury Secretary Steve Mnuchin’s, who is asking for a ‘clean raise’. However, the Director of the Office of Management and Budget is, you guessed it, Mick Mulvaney, who has stated the Government should not pass a clean bill without a health care bill first.

This chaos has caused for major concern for two Senators; Susan Collins of Maine and Jack Reed of Rhode Island. The two were caught in a ‘hot mic’ wondering out loud how on Earth, with all the chaos in Washington right now, they are going to be able to pass a budget or raise the debt ceiling.

So far, the market has not even blinked at this potential danger. Decent earnings have pushed the Dow Jones above 22,000. However, it should be pointed out that the market reached an all-time high without the VIX on a relative low, which I consider a contrary indicator.  In recent weeks in the VIX pit, we have seen increased bets on a rising VIX, primarily in September and October dated options.

The VIX is currently under 10.50 and the country is driving down the highway on cruise control, oblivious to any potential danger, without anyone behind the wheel. With the summer drawing to an end, and so much at stake with so few people caring, wake me up when September ends. -Green Day, American Idiot, 2004.

-Joe Tigay