Investors unfazed by shutdown, but fear looming debt limit

(MoneyWatch) As federal agencies locked their doors Tuesday, investors made clear they remain open for business. Stocks shrugged off the government shutdown, with leading indexes all gaining ground.

Indeed, for now most market observers are looking past the immediate closure and girding for what they say is a potentially far more damaging political clash over the country's debt ceiling. Without a bill in Congress to raise the government's borrowing limit, the U.S. Treasury Department's coffers are expected to run out of money by Oct. 17, although the agency could likely extend the deadline for a week or two after that date. 

The Dow Jones industrial average gained 62 points, or 0.4 percent, to close at 15,192. The S&P 500 rose 13 points, or 0.8 percent, to 1,695, and the Nasdaq composite added 46 points to 3,818.

"Investors have learned that the mistake is to get out of the market, because eventually these problems are resolved and the market moves to higher ground," said Ed Yardeni, president and chief investment strategist for institutional investor advisory Yardeni Research, alluding to the bull market that started in 2009.

Not that the shutdown doesn't sting, especially for the roughly 800,000 federal workers who were required by law to go on furlough starting today. Companies who do business with the government also face a loss of revenue. Both developments could dent economic growth by reducing spending. And an extended shutdown would harm the already fragile confidence of consumers and businesses, noted Ian Shepherdson, chief U.S. economist with Pantheon Macroeconomics.

More broadly, the lockdown is a distraction for the government, and will harm its efficiency even once the present crisis is sorted out, wrote Josh Bivens, research and policy director with the liberal Economic Policy Institute.

Still, a one-week shutdown would reduce growth in the last three months of the year by a modest 0.16 percent, research firm IHS Global Insight calculates. That wouldn't derail the recovery.

By contrast, failing to lift the debt ceiling could directly hurt a wider swath of the population by, for example, forcing the government to suspend payments to Social Security and Medicare recipients. Without a hike in the debt ceiling, the government would also have to immediately eliminate the $742 billion deficit, a massive hit in spending that dwarfs the $44 billion in sequester cuts that took effect in March. And for the economy at large, hitting the ceiling could in theory cause the government to default on its debts for the first time in U.S. history.

Such a default would represent uncharted waters, with unknown global financial implications. 

"Ultimately, the more critical issue is the debt limit -- that's scarier for markets," said Jim O'Sullivan, chief U.S. economist with High Frequency Economics. "The symbolism of a U.S. default would be quite negative for confidence in the U.S. and financial markets globally. Crossing that line once, even if it's quickly reversed, would be hard to take back."

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The U.S. economy could be jolted even if Congress breaks the impasse and strikes a deal to lift the debt ceiling. In August of 2011, Standard & Poor's lowered the government's credit rating even after lawmakers had agreed to increase the borrowing cap.

Economists with IHS said that failing to raise the ceiling "will undoubtedly drive the major credit rating agencies to lower the U.S. sovereign debt rating." Depending on how financial markets react, that could make it more expensive for the U.S. to borrow money, a potentially serious blow for an economy that is still struggling for traction.

If history is any guide, stocks are likely to come under increasing pressure as the government nears its debt limit. In 2011, the S&P 500 fell 17 percent in two weeks as the deadline neared to raise the borrowing cap.