Washington's chaos now has a price

Congress passed a 45-day continuing resolution on 30 September and avoided a federal government shutdown with hours to spare. The stopgap came at a high political price. It led to the historic ouster of the House Speaker and left Capitol Hill in disarray. Washington's dysfunction has stopped being a spectacle and started to carry a financial cost.

From stopgap to ouster

Kevin McCarthy won the speakership in January only after fifteen rounds of voting, and part of the price was a rule letting a single member force a vote to remove him. By relying on Democratic votes to pass the stopgap, he handed his hardline critics their pretext. Matt Gaetz moved to vacate the chair, and the House voted to remove McCarthy, the first Speaker ever ousted this way. Until a successor is chosen the House is effectively frozen, and the new funding deadline of 17 November is close.

The stopgap itself settled almost nothing. It kept spending at last year's levels and left out new aid for Ukraine, which the Senate had wanted, so the fights over both the size of the budget and support for Kyiv have simply been postponed. None of the twelve annual appropriations bills has been enacted. A House without a Speaker cannot pass any of them.

The arithmetic that toppled McCarthy has not changed. Republicans hold only a narrow House majority, so a handful of members can block any candidate for Speaker, as January's marathon vote showed. A successor who again leans on Democratic votes to keep the government open risks the same fate, while one who refuses makes a shutdown in November more likely. The incentives that produced this week's vote are still in place for the next deadline.

Paying for paralysis

Bond investors increasingly want extra yield for holding long-term US debt. The world's main reserve currency issuer lurches from one debt-ceiling crisis to the next, relies on short-term spending patches and is gripped by factional paralysis. That wears away the institutions that make Treasuries risk-free. Political risk, once the preserve of emerging markets, has moved to the world's benchmark borrower.

The rating agencies have noticed. Fitch cut America's rating to AA+ in August, pointing to a deterioration in governance that included repeated debt-limit standoffs, twelve years after Standard & Poor's did the same following the 2011 debt-ceiling fight. Moody's is now the only one of the three big agencies still granting the country its top grade. The ten-year Treasury yield has climbed to its highest since 2007, and although most of that move reflects Fed policy and heavy issuance, a government unable to plan its spending more than weeks ahead gives investors one more reason to demand extra.

How the premium builds

The mechanism is gradual. Each standoff raises the small probability that a payment is delayed, and investors in long bonds must carry that risk for decades. Shutdowns also interrupt the data that markets and the Fed rely on, since statistical agencies stop publishing when their funding lapses. Weaker budget discipline makes it harder to believe that deficits will ever be brought under control, and that doubt shows up as a steadily higher term premium instead of a sudden crisis.

The cost compounds through the interest bill. Much of the debt issued at near-zero rates in 2020 and 2021 is short-dated and is being refinanced at yields above 5 per cent on Treasury bills and above 4.5 per cent further out. Every extra basis point that political risk adds to long yields is paid on trillions of dollars of new issuance, and it is paid by the same Congress that cannot agree how to fund the government for more than six weeks at a time.

Who bears it

The losers extend well beyond Washington. Mortgage rates and corporate borrowing costs are priced off Treasury yields, so a political premium on government debt is passed straight to homebuyers and companies. Federal contractors and government workers face the prospect of unpaid weeks each time a deadline approaches. Money-market funds and other holders of short-term bills are the relative winners, collecting high yields on paper that matures before any plausible default date.

The limits of the argument

The case against is strong. Treasuries remain the market investors run to in a panic, and the dollar still makes up the majority of central bank reserves. When S&P downgraded America in 2011, Treasury yields fell as investors sought safety in the very debt that had been cut. Shutdowns have come and gone, including a record 35-day closure over the winter of 2018 and 2019, without lasting damage to demand for American debt.

What differs now is that the dysfunction compounds heavy borrowing. In 2011 the Fed was buying bonds and inflation was low, whereas today the Fed is shrinking its holdings and the deficit is large at full employment. Britain's gilt crisis last autumn showed how quickly a political shock can reprice a G7 bond market when buyers are already nervous. The next tests are the choice of a new Speaker, the mid-November funding deadline and the Treasury's refunding announcement in early November, which will reveal how much long-dated debt the market must absorb. The debt ceiling itself is suspended until early 2025, so for now the fights are over spending rather than default.

Congress's inability to pass a budget now has a price, and American borrowing costs will stay higher for as long as the brinkmanship lasts. If the House is still leaderless as the 17 November deadline nears, the term premium on long Treasuries will rise further, and homebuyers and corporate borrowers will pay it.