In the debt ceiling fight, politicians and markets had operated relatively independently of each other for a surprisingly long time, as the sense of crisis in Washington has not seemed to translate to Wall Street. But as time ticks down to Tuesday's deadline to reach a deal, that disconnect is starting to deteriorate. Absent an agreement by Monday, analysts say, markets' optimism could easily falter.
Congress will be working through the weekend to strike a deal. But at this point, even a deal might not forestall a decrease in confidence in U.S. debt. Ratings agency Standard & Poor's has indicated that it would consider downgrading the country's 'AAA' credit rating if lawmakers fail to strike a deal cutting deficits by $4 trillion over 10 years. This was the amount of deficit reduction that President Obama had been working on with House Speaker John Boehner—the so-called "grand bargain"--would have achieved. House conservatives resoundingly rejected that plan. None of the debt ceiling solutions currently on the table would come close to this benchmark.
Meanwhile, markets have been relatively optimistic through the debt crisis, given the potentially dire and ultimately unknown effects of default. Yields on 10-year Treasury bonds have held relatively firm, with a rate of 2.98 on Thursday, exactly where the rate sat two weeks ago on the 14th. But cracks are showing in investor confidence. Thursday's 10-year rate was down 0.05 points from Monday—a small drop, perhaps, but one that might signal a broader shift to safer investments. The Dow Jones Industrial Average has dropped 4 percent in the last five days. And in the week ending July 27, fund managers shifted $37.5 billion out of money market funds. Normally considered among the securest of investments, these funds invest in short-term securities, like Treasury bonds. The shift in assets shows that investors are worried about the Treasury's ability to pay on shorter-term bonds.
Paying more heed to political realities than to markets is altogether logical for a lawmaker, says Andy Laperriere, senior managing director at investment advising firm ISI. "Personally, I think that the greater bearing that will influence members of Congress is not whether the market drops 5 percent, which it hasn't, but whether millions of people who were accustomed to getting a check from the federal government are not going to get them." says Laperriere.
Sal Catrini, a markets commentator at investment bank and brokerage firm Cantor Fitzgerald, says that much more delay on a debt ceiling agreement could shake stability in the business world. He points to large companies like Caterpillar and UPS that have posted good earnings yet are nervously awaiting the negotiations' outcome. "Big companies talk very specifically about the sentiments being poor in light of this debt crisis. So even if you are bullish, now you think ... 'I don't have visibility. All my customers who give me orders, they don't know what's going on.'" He adds, "This needs to be done. We need to move on. Uncertainty needs to leave the markets now."
The bottom line is that this weekend is crunch time, with both markets and lawmakers waiting until the last minute to react in the face of default. "I think if it gets to the point where we're looking at Monday morning, Monday midday and there isn't any movement [in negotiations], then I think people will start to get very anxious," says Gus Faucher, director of macroeconomics at Moody's Analytics. And while the particulars of the plan may not matter, Faucher believes that the agreement will need to meet three crucial criteria: "As long as there's a bipartisan plan that looks like it will (a) raise the debt limit, (b) raise it so we don't have to deal with this until after the  election, and (c) will pass, that will mollify markets." Whether the final deal can achieve these objectives remains to be seen.