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Debt Limit Resolution: As the Dust Settles

John-Rothans

Written by Philip Diehl

Oct 18, 2013

In a recent Institutional Investor article and blog post, I wrote about how none of the big issues in Washington—QE3, the debt limit, and funding the government—are likely to be settled anytime soon. This prediction was borne out on Wednesday when Congress delayed decisions on funding the government until January 15 and increased the debt limit for less than four months. And economic uncertainty caused by the budget and debt crisis will no doubt reduce economic growth this quarter, probably eliminating any chance the Fed will begin tapering QE3 this year.

So, nothing seems to have changed. We simply kicked the can into next year. While the GOP took a good deal of self-inflicted damage in the standoff, this was not a victory for Democrats in terms of achieving any of their budget objectives. The deep budget cuts under sequestration remain in place and will deepen with more cuts in January. All is as it was before.

But at a deeper level, there are two significant consequences of this fiasco.

Impact on the GOP

Tea Party Favorability Declines

Favorable views of the Tea Party declined across all political parties as a result of the debt ceiling showdown.

GOP leaders in the Senate and GOP moderates, generally, are now determined to rein in the GOP’s Tea Party caucus to prevent a repeat performance next year. They might have some success. Then again, they might not. I’m of the “might not” persuasion.

Members of the congressional Tea Party have very different incentives from the rest of the GOP. They occupy many of the safest seats in Congress and, unlike some establishment Republicans, including members of the GOP leadership, they’re unlikely to be defeated next year. Also, they enjoy strong support in conservative media and ample campaign funds thanks to virtually unlimited campaign contributions under the Supreme Court’s Citizens United decision.

Unlike establishment Republicans, Tea Party members don’t care about their influence in Congress. Their agenda is to cut, cut, cut government, and they can’t be induced to cooperate with the GOP leadership with funding for their favorite programs or projects in their districts. So, the leadership has little leverage over them.

Moreover, the Tea Party remains deeply skeptical about all the crying and gnashing of teeth over the prospect of a government default. They recall that the dire warnings about sequestration spending cuts did not seem to materialize, and they think the same is true about hitting the debt limit. In fact, if the debt limit had not been raised this week, the nation would not have defaulted—not immediately—and the Tea Party could have said, “We told you so”, greatly increasing their credibility. However, default was inevitable by November 1.

Ted Cruz

Senator Ted Cruz's popularity declined among all groups except for the Tea Party, with which his popularity rose during the government shutdown, according to recent findings from the Pew Research Center.

Also, Tea Party members with national political ambitions benefit from the intense media attention their incendiary rhetoric and obstructionist actions generate. This strategy has made novice Senator Ted Cruz of Texas the favorite presidential candidate of the conservative wing of the GOP. He has paid an enormous price in terms of his effectiveness in Congress, but that matters not a whit to him since he has no interest in passing legislation.

Finally, for the most part, Tea Party members aren't bothered if their actions lead to defeat of their establishment Republican colleagues. In fact, their defeat will help purify the GOP, move its center of gravity in their direction, and make the GOP a more effective instrument for achieving their policy and political objectives.

As I said, I’m skeptical that the congressional Tea Party can be called to heel.

Impact on Markets

Despite all the fireworks, markets remained calm right up to the end of the crisis. Yes, there were short-lived effects on interest rates for short-term Treasuries, but otherwise, not so much. Markets remained confident that an agreement would be reached before their interests were affected. (That might not be the case for the rest of us.)

The markets’ assessment might change if Fitch, which put the U.S. credit rating on a negative watch, now downgrades the rating, or if the negative effects on the economy are greater than expected. But with its confidence borne out that a last-minute solution would be found, markets are likely to ignore any brinksmanship in the next round of budget and debt limit confrontations next year.

That leaves QE3. Markets are likely to remain highly sensitive to uncertainty related to, or decisions to, taper QE3. With President Obama’s nomination of Janet Yellen, who favors the Fed’s current policies, the tapering drama—when will it start and how fast will it proceed—is likely to extend into 2015.

In 2014, the Fed is where the action will be.

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