Fresh from a budget fight so raw that the Republican speaker ofthe U.S. House cursed the Democratic leader of the Senate outsidethe Oval Office, President Barack Obama and Congress are headingfor an even bigger confrontation over raising the nation's debtlimit.

U.S. Treasury bond investors — who most directly bear the riskof a government default — aren't alarmed. In a sign of thedisconnect between Washington and Wall Street, investors remainconfident the two sides will compromise rather than inflict whatObama called “catastrophic” consequences. Yields on long-term U.S.debt are near record lows.

“It's ugly in Washington, and getting uglier,” said MatthewDuch, a fund manager in Bethesda, Maryland, for CalvertInvestments, which oversees more than $12 billion in assets. “Butthat is just resulting in even lower rates as the market is muchmore concerned about growth than if the U.S. will be able to paytheir bills.”

That hasn't stopped Republicans and the president from movingtoward a clash, with House leaders vowing to exact deep spendingcuts in exchange for raising the borrowing ceiling and Obama sayinghe won't negotiate on the debt. The U.S. Treasury is bumping upagainst its legal borrowing limit.

“Heretofore, they've been playing with a cherry bomb in economicterms,” said Steve Bell, a former Republican Senate budget aide.“When they start playing with the debt ceiling in February, theyare starting to play with C-4,” he said, referring to the powerfulplastic explosive material.

When partisan gridlock last brought the government to the brinkof default in August 2011, the stock market fell and Standard &Poor's cut the nation's credit rating. After House Speaker JohnBoehner, an Ohio Republican, withdrew from negotiations on July 22,2011, the S&P 500 Stock Index fell more than 16 percent in thenext 11 trading days.

Bond investors were unrattled. Yields on 10-year U.S. Treasurynotes declined from 2.96 percent on July 22 to 2.56 percent on Aug.5, 2011, the day of the S&P downgrade. Yields continued todrop, reaching 1.72 percent on Sept. 22 of that year. Yields wereat 1.91 percent at 5 p.m. New York time yesterday, according toBloomberg Bond Trader data.

“The market is not worried about default,” said Zach Pandl, aninterest-rate strategist in Minneapolis at Columbia ManagementInvestment Advisers LLC, which oversees $340 billion.

“In the U.S., the debt level is lower than comparable countries,growth is higher and we have a unblemished track record in the U.S.of debt repayment, all of which has helped calm investor concerns,”he said. “The process is messy, but the outcome is alwaysacceptable.”

Averting Crisis

The budget deal that Obama and lawmakers struck this weekaverted the so-called fiscal cliff of income-tax increases on mostAmericans and delayed automatic spending cuts until March 1. Sowhile Obama has pledged not to negotiate over the debt limit, thattiming raises the possibility that talks to address the automaticcuts would also include the debt ceiling.

Treasury Secretary Timothy F. Geithner, a key figure in Obama'sresponse to the recession and the 2011 debt-limit talks, plans toleave the administration at the end of January, even if thepresident and Republicans haven't reached an agreement on the debtceiling, said two people familiar with the matter.

The two sides start far apart.

House Republican leaders have said they will demand a dollar inspending cuts for every dollar that the federal debt limit isincreased. House Republicans plan to discuss strategy at a retreatin Williamsburg, Virginia, later this month.

In contrast to the Republican focus on spending cuts, Obama saidon Dec. 31 that any deficit reduction to block scheduled spendingcuts would have to be “balanced” to also contain more taxrevenue.

The administration believes the composition of deficit savingsincluded in the tax deal to pay for a two-month delay in theautomatic spending cuts sets the template for any future deal,according to a White House official, who requested anonymity. The$24 billion in savings was split evenly between new revenue andspending reductions, half of which came from defense.

The U.S. reached its $16.4 trillion legal debt limit on Dec. 31,and the Treasury Department began using extraordinary measures tofinance the government. It will exhaust that avenue as early asmid-February, the Congressional Budget Office says.

Bitter Climate

Negotiations over raising the limit will play out in a bitterpolitical climate. Some Republicans complain that Obama'sinsistence on increasing tax rates for the wealthy rather thanreverting to a more flexible position he took in 2011 amounts tousing his re-election victory to bully them.

Several also grumbled about a campaign-style event the presidenthosted at the White House on Dec. 31 criticizing Republicans duringa delicate moment of the tax talks.

“I just listened to the president, and my heart's stillpounding,” Senator Bob Corker, a Tennessee Republican, said on theSenate floor. “I am very disappointed to hear what the presidentjust had to say in front of a pep rally, something very unbecomingof where we are at this moment.”

Emotions ran so high during the latest round of talks that atone point Boehner told Senate Majority Leader Harry Reid, a NevadaDemocrat, to “Go f— yourself,” according to two people familiarwith the conversation, which took place just steps from the OvalOffice.

Frustration also boiled over as House Republicans left aconference meeting on Jan. 1 at which they were presented with thedeal the party's Senate leaders negotiated with the White House.“On Nov. 6,” the day Obama was re-elected, “the American peoplemade a serious mistake,” Representative Trent Franks, an ArizonaRepublican, said in an interview.

Obama wasn't only re-elected, he became the first president inmore than five decades to win at least 51 percent of the votetwice, which not even Ronald Reagan achieved in the 1980s.Democrats in November expanded their majority by two votes in theSenate and, while Republicans maintained a majority in the House,Democratic House candidates nationwide won 1 million more votesthan Republican contenders.

The tax deal signed on Jan. 2 by Obama, which raised rates onannual income above $450,000 for couples, produced a split in theHouse Republican leadership. Boehner and Budget Committee ChairmanPaul Ryan of Wisconsin voted for the bill. Majority Leader EricCantor of Virginia and Whip Kevin McCarthy of California, theparty's No. 2 and 3 leaders in the chamber, voted against it.

Obama Emboldened

Lining up against the Republican leadership is an emboldenedpresident, who appeared before the television cameras at the WhiteHouse Jan. 1 to draw a line against accepting any conditions for anincrease in the debt limit.

“I will not have another debate with this Congress over whetheror not they should pay the bills that they've already racked upthrough the laws that they passed,” Obama said. “We can't not paybills that we've already incurred.”

That sparked anger among some House Republicans.

“If the president thinks that he's not going to negotiate, he'dbetter think again,” said Oklahoma Representative Tom Cole,according to NBC News. “He's president of the United States. He'snot emperor of the planet.”

Senator Michael Bennet, a Colorado Democrat, said he's worriedabout the possibility of a debt default because of a standoffbetween congressional Republicans and the White House.

“We were downgraded because of concern of the political riskthat the two parties couldn't work together,” Bennet said in aninterview with Bloomberg Television's Peter Cook for the program“Capitol Gains” airing Jan. 6. “There still isn't evidence that wecan do that.”

The next chapter in the skirmishing over the nation's financesplays out during a phase of the political calendar that gives Obamaunusual access to the power of the presidential bully pulpit, withhis inauguration for a second term and State of the Union addressin the coming weeks.

The administration is considering how to make the best use ofthe opportunities, the White House official said. Obama is likelyto repeat tactics he used to mobilize public opinion in the fightover tax rates, including a social media campaign andcampaign-style appearances outside Washington, the officialsaid.

Patrick Griffin, who was White House congressional lobbyingchief for Democratic President Bill Clinton, said the debt limit“is not the leverage that Republicans think it will be.”

Obama “is completely in a different position” than during the2011 debt talks, Griffin said.

Fresh Mandate

The president has a fresh political mandate from hisre-election. And corporate leaders anxious to avert the economicdisruption of a debt default have taken a more prominent role inpressing for compromise, Griffin said.

Obama also has gained more public credibility on the deficit, inpart because he has spent more time speaking out about wanting tobring down government debt, Griffin said. A Bloomberg National Pollconducted Dec. 7-10 found 40 percent public approval of Obama'shandling of the deficit versus 32 percent in June 2011, at thestart of the last debt-limit talks.

Congressional Republicans have now twice backed off threats tostand fast in the face of a financial crisis, agreeing to thedebt-limit increase in August 2011 and reaching a deal to avert thetax increase on Jan. 1.

“Republicans conceded they did not want to create a crisis onthe fiscal cliff,” Griffin said. “Why would they want to turnaround and create an even bigger crisis on the debt limit?”

Bloomberg News

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