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Cloudy skies shroud the Capitol in Washington, Monday morning, Oct. 14, 2013.J. SCOTT APPLEWHITE/The Associated Press

Democratic and Republican Senate leaders are on the verge of an agreement to end the U.S. budget showdown, earning a reprieve from skittish traders on Wall Street and shifting attention back to the much more acrimonious House of Representatives.

Congressional aides predicted Majority Leader Harry Reid and his Republican counterpart Mitch McConnell could seal an agreement Tuesday, just two days before the Treasury Department says it will run out of borrowing capacity.

Mr. Reid and Mr. McConnell were working late Monday on a proposal that would reopen the federal government through the middle of January and lift the statutory debt ceiling enough to allow the Treasury Department to borrow until early February.

The latter is crucial, as the Treasury estimates it will run out of accounting manoeuvres to stay below its current $16.7-trillion (U.S.) limit by the end of the week, introducing the once unimaginable prospect of the world's largest economy defaulting on its debt. That would undermine faith in treasuries bonds, the foundation of the international financial system.

President Barack Obama warned Monday that "we stand a good chance of defaulting" if lawmakers fail to resolve their differences this week. "They can solve this problem today," Mr. Obama said during a visit to a Washington soup kitchen, adding that elections – not budget deadlines – are the place to resolve partisan differences. "Between elections we are supposed to be governing."

According to various reports from Capitol Hill, the agreement to pull back from the brink involves broader budget talks that would put current spending levels and tax rates on the table, and could force Democratic lawmakers to confront Republican demands that something be done to curb the rising cost of federal health and retirement benefits. The deadline to complete the negotiations would be the middle of December, Politico reported, citing unnamed sources.

As the risk of default appeared to diminish, traders turned from sellers to buyers. Stock prices in New York dropped when markets opened Monday, as lawmakers failed to conclude an agreement on the weekend. Sentiment shifted after Mr. Reid and Mr. McConnell said in the afternoon in separate statements on the Senate floor that they were "optimistic" that a deal was at hand.

The Standard & Poor's 500 Index, the broadest measure of U.S. equity prices, and the Dow Jones Industrial Average, another closely watched measure of corporate health, both gained about 0.4 per cent. Canada's financial markets were closed Monday for the Thanksgiving holiday.

Investors were encouraged by the body language in Washington more so than substance, as equity prices rose despite the lack of a concrete resolution.

Mr. Reid and Mr. McConnell started talking on the weekend for the first time since Congress failed to renew the government's spending authority at the beginning of October, prompting the cessation of all non-essential federal services. Small groups of Democratic and Republican lawmakers have started getting together to exchange ideas. Reid Ribble, a Republican congressman from Wisconsin, told Bloomberg Television it was the first time he had seen that happening since he won his House seat in 2011.

Washington's newfound spirit of togetherness could be tested when the Senate resolution is presented to the Republican majority in the House.

Last week, Speaker John Boehner dropped his demands that co-operation on the shutdown will come only if President Barack Obama agreed to rewrite the 2010 health-care law that stands as his signature domestic achievement. But he only offered to raise the debt ceiling for six weeks in order to retain leverage in broader talks over government spending levels. So far, he has resisted alienating the Tea Party faction of his caucus, without which Mr. Boehner needs Democratic support to move legislation.

The House Republican caucus was scheduled to meet Tuesday morning.

Investors were not entirely confident that U.S. politicians can be counted on to avoid the worst. The U.S. dollar fell against the yen on Monday. The price of gold, a favourite haven at times of financial uncertainty, edged higher.

Mr. Obama summoned the leaders of the majorities and minorities in the Senate and the House to the White House for a mid-afternoon meeting on Monday, and then postponed the huddle to give Mr. Reid and Mr. McConnell more time to negotiate. The White House insisted the delay was a positive sign, not a negative one.

With a file from The Associated Press

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