Running out of runway

US debt: Politicians shouldn't need the threat of market mayhem to do their jobs. But that may be the case in Washington, as the August 2 deadline to boost US borrowing authority nears. Weekend on-again, off-again talks brought more confusion than clarity. The coming days may test investor assumptions about the inevitability of a deal.

The White House and Congress had been hoping to reach an agreement by last Friday to raise the debt ceiling and cut trillions in debt over the next decade. That would have given lawmakers time enough to craft legislation and move it across Capitol Hill without a mad dash. The House and Senate still have room to do all that, but they are rapidly running out of runway. The working assumption among investors has been that Washington would eventually come to its senses and compromise. Such optimism has been reflected in both US government bonds, where yields continue to hover around record lows, and on Wall Street, where stocks are at their highest levels of the year.

But it’s hard to see how the situation on the ground merits such equanimity. White House chief of staff Bill Daley is probably correct in warning that there will be a "few stressful days" ahead for financial markets. Each side is working on its own bill. Senate Democrats are drafting a $2.7 trillion deficit reduction package that would also raise the debt limit through 2012. House Republicans, on the other hand, seem ready to push a two-stage proposal with the first part being an immediate $900 billion debt ceiling increase matched with $1.2 trillion in budget cuts over 10 years.

In isolation, each initiative may prevent potential financial catastrophe on Aug 3. Trouble is President Barack Obama says he won't sign a short-term increase. And Republicans are expressing doubt about the legitimacy of proposed cuts by Democrats. Neither bill, at this point, has enough bipartisan support to pass both chambers and get to Obama's desk. So who blinks first? Chances are it may be markets - with legislators scurrying behind.