By Rodrigo Campos
NEW YORK (Reuters) - Investors may be tempted to shy away from stocks in the next week or two as the latest version of the fiscal follies plays out in Washington.
It's understandable. The prospect of a government shutdown or, worse, default on the federal debt, rekindles memories of 2011 when Washington's infighting prompted the loss of the United States' triple-A credit rating and was a primary driver behind the stock market's last full-on correction.
The sense from Wall Street analysts this time, however, is that the current drama is likely to feature more bluster than bravado and contains overblown threats.
"Looking back at the pattern that has emerged since the debt ceiling fiasco back in 2011, the Republican leadership got the message that if there is a government shutdown, most likely their party is going to get blamed," said Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management in Menomonee Falls, Wisconsin.
"They're going to be very sensitive to that public sentiment as we get closer to a midterm election year" in 2014, Jacobsen said.
"In spite of all the brinkmanship being talked about ... there will be a deal and then we will move on," said Stephen Massocca, managing director at Wedbush Equity Management in San Francisco.
This autumn's standoff comes with two separate but related deadlines.
First, failure to come up with a budget deal by the end of the month risks a federal government shutdown starting October 1. Then, by mid-October lawmakers must vote to raise the federal debt ceiling to prevent a default.
The posturing has been under way for weeks. In the latest move, the Republican-controlled House of Representatives passed legislation on Friday to fund federal agencies through mid-December but also inserted a provision killing President Barack Obama's landmark healthcare overhaul.
Democrats, who control the Senate, have said they will strip out that provision when the bill comes before the Senate, most likely next week.
Wall Street players are sanguine about events unfolding in Washington.
"Uncertainty will probably rise ahead of these events, but we think this is likely to be short-lived and probably less severe than some other recent episodes," said a Goldman Sachs research note.
In fact, the current episode could prove to be an empty threat, like the so-called "fiscal cliff," last December. After weeks of dire predictions of big tax hikes and draconian spending cuts if no deal was reached, lawmakers came to a last-minute accord, and the market kicked into high gear for 2013. The S&P 500 is up more than 22 percent year to date on a total return basis, including re-invested dividends.
"While we could get a pullback on worries about the debt ceiling and the continuing resolution, my guess is it will go the same way as the fiscal cliff went - a bunch of sound and fury signifying nothing," said Jeffrey Saut, chief investment strategist at Raymond James Financial in St. Petersburg, Florida.
"If the market pulls back on (Washington) worries, I think it's a buy," said Saut.
As the budget battle heats up, the lack of angst among investors was reflected in a fall in the CBOE Volatility Index <.VIX>, Wall Street's favorite measure of fear. It ticked down to 13.12 on Friday and has posted three straight weeks of losses for a total drop in that period of 23 percent.
Next week on Wall Street, the widely followed Dow Jones industrial average <.DJI> will open Monday with three new components as Goldman Sachs <GS.N>, Visa <V.N> and Nike <NKE.N> replace Bank of America <BAC.N>, Hewlett-Packard <HPQ.N> and Alcoa <AA.N>.
ANOTHER TAPER TANTRUM
Even though the market has a low chance of disruption from the fiscal fighting, there might still be a bearish signal from Washington.
"Fiscal retrenchment" in Washington was one of the reasons cited this week by the Federal Reserve for not reducing its stimulus program of $85 billion a month in bond purchases. The policy has kept downward pressure on interest rates and has helped lift the S&P 500 <.SPX> this year.
The reduced likelihood of a political impasse over the budget could then open the door for the Fed to begin tapering as early as late October when it holds its next policy-setting meeting.
That possibility was raised by St. Louis Fed President James Bullard on Friday, noting that the decision still depends on data about the economy. He also said the Fed has maneuvering room as along as inflation is low.
"One of the things that pushed the Fed into the precautionary side was the fiscal issues. They realized what sort of effect that could have on the economy and decided not to taper," said Wells Fargo's Jacobsen.
"It is entirely possible that on October 30 we could see a slight tapering because we'll have passed some of the chaos in (Washington) D.C. if there is a resolution of the budget issues," he said.
(Changes wording to "last" from "most recent" in second paragraph)
(Reporting by Rodrigo Campos, additional reporting by Chuck Mikolajczak; Edited by Dan Burns)