Debt showdown: Why Wall Street might be more worried than it appears

You’d be forgiven for thinking that Wall Street is fiddling while Washington burns.

Here we are, two days before a debt-limit deadline that the US Treasury has pegged as a “catastrophic” risk for the economy, and the Standard & Poor’s 500 stock index is not far from its all-time high.

The Dow Jones Industrial Average spent Tuesday above the 15000 level where the index has essentially hovered since May.

Are investors disagreeing with Treasury Secretary Jack Lew? Do they think it’s no big deal if Congress fails to raise America’s debt limit by Oct. 17?

No. The apparent equanimity on Wall Street doesn’t mean that traders lack awareness of what’s at stake – basically that the government needs new borrowing authority or it soon won’t be able to meet all its financial obligations.

The stock market is priced for what investors think will happen – a last-minute deal to raise the debt cap – not for the bad news that might happen.

Yes, the deadline is dangerously near, but there are still those precious two days to go.

“Clearly, this is not a market that expects a default to occur” by the US Treasury, says David Joy, chief market strategist at Ameriprise Financial in Minneapolis.

“We have become inured to these episodes over time, and have come to expect last-minute resolutions,” he writes in a new commentary on the market’s behavior. “Reportedly, progress toward a deal is being made, albeit slowly. But we will all breathe a little easier when it is finally in hand.”

The last point Mr. Joy makes is vital.

Investors aren’t taking the antics on Capitol Hill casually. When a standoff in Congress took the nation near the brink of default in 2011, after all, the economy’s growth took a hit even though the debt limit ended up being raised in time.

And there’s no guarantee that the current fiscal clash will end that smoothly.

If it starts looking as if “getting to yes” is doubtful, that won’t be greeted with yawns on Wall Street.

Already, the budget impasse that resulted in a partial federal shutdown is having negative effects on economic growth and consumer confidence.

But for stock traders, the risk of a new financial crisis – the danger that Secretary Lew warned about – needs to be balanced against another risk: You could sell stocks today to be “safe” and then watch share prices rally when a deal gets done.

Beyond the fiscal disarray in Washington, the US economy has been generally improving – and luring investors who see growth slowing in emerging-market nations such as China and India.

Many investors are banking on a climate of steady economic growth, even if the current impasse gets resolved by simply setting the stage for another budget showdown in the new year.