Wall Street warns: Under a divided government, the 2027 debt ceiling showdown will test the "safe-haven myth" of U.S. Treasuries.

Title context: Wall Street warns: Under a divided government, the 2027 debt ceiling showdown will test the "safe-haven myth" of U.S. Treasuries. Text: The U.S. midterm elections are settled, with Democrats unexpectedly winning control of Congress, bringing the market the classic combination of a divided government. Historically, investors have tended to welcome such political gridlockbecause it means policy is constrained and spending is restrained. On Wednesday, as news of the Democratic landslide spread, the U.S. Treasury yield curve shifted lower across the board, continuing this tradition. Data shows that since the mid-1990s, under divided government, the 10-year U.S. Treasury yield has on average been at lower levels both 1 month and 12 months after midterm elections. This time, however, Wall Street's concerns are focused on another issue: the debt ceiling. Deutsche Bank strategist George Saravelos noted: "The single largest source of U.S. domestic policy uncertainty is the debt ceiling, which will become a binding constraint around the second quarter of next year." Currently, the U.S. federal government has only about US$800 billion of headroom left before reaching its US$41.1 trillion statutory borrowing limit. Strategists expect the government to hit the ceiling in the first half of 2027. At that point, the Treasury can use extraordinary accounting measures to free up some borrowing capacity to avoid default, but Congress must ultimately raise or suspend the debt ceiling to fully eliminate the risk of technical default. Full Democratic control of Congress means a confrontation with the Trump administration over government borrowing could be protracted. Fitch Ratings warned last month that Democratic control of Congress could increase the risk of political brinkmanship over the debt ceiling. The agency also said the outgoing Republican-led Congress could raise or suspend the debt ceiling before its term ends at year-end; otherwise, the issue will become a major test for the new Congress. BMO Capital Markets strategist Vail Hartman said: "If Congress fails to resolve the debt ceiling issue before year-end, financial markets could face a protracted debt ceiling stalemate in 2027." He expects Democrats to use the debt ceiling as "strong leverage to extract concessions from the Trump administration," with the result likely being distortions in Treasury bill prices around the expected "X-date" (the date government funds are exhausted) and increased volatility in cash and repo markets. Looking back at history, whenever a debt ceiling confrontation approaches, investors typically sell Treasury bills maturing around the X-date and buy securities maturing before or after the X-date, leaving a clear "distortion node" on the yield curve. Currently, with several months still to go before the ceiling is reached, the Treasury bill curve has not yet shown obvious signs of concern. But the CIBC strategist team (led by Michael Cloherty) reminded investors on Wednesday that they should "price more risk premium" into money markets before 2027. The deeper problem lies in fiscal fundamentals. Schroders global (Schroders) senior economist George Brown pointed out that the current U.S. fiscal deficit is about 6% of GDP, publicly held debt has exceeded US$32 trillion (not yet including intragovernmental obligations such as Social Security and Medicare), and both the Trump administration and the incoming Democratic Congress have promised new spending"this assumption (that divided government is bullish for Treasuries) deserves re-examination." He further warned: "If political compromise increasingly means larger deficits rather than fiscal consolidation, investors may demand a higher term premium to hold long-term Treasuries." This could cause the U.S. Treasury yield curve to steepen. It is worth noting that past debt ceiling stalemates have raised market concerns that the Treasury may be unable to pay interest on some maturing Treasury bills on time, triggering fears of a "technical default." Such episodes of government dysfunction have also prompted rating agencies to actin August 2023, Fitch downgraded the U.S. sovereign rating by one notch to AA+, citing the political wrangling over the debt ceiling that pushed the United States to the brink of default. Market expectations are broadly pessimistic about whether Congress can defuse the risk before year-end. CIBC's Cloherty expects Republicans to try to raise the borrowing limit during the "lame-duck" session, but he believes the effort will fail. That means the new Congress will face what CIBC calls "a fierce debt ceiling battle in the fourth quarter of 2027 and beyond."