(Bloomberg) -- Sushil Wadhwani warns a deeply divided Congress may push the US to the brink of a default and credit downgrade before it resolves its standoff over the debt ceiling. 

Wadhwani, a veteran hedge fund manager and advisor to UK Chancellor Jeremy Hunt, says a market shock akin to 2011 — or worse — is needed to spur US lawmakers to action.  

“The risk this time has to be that you will need significant market turbulence to get these folks to agree,” the founder and chief investment officer at quantitative firm PGIM Wadhwani said on Bloomberg TV. 

Anxiety over a possible debt ceiling default has caused rates on short-dated bills to soar and contracts against a default over the next year to trade near a record. Yet the reaction is tame compared with 12 years ago, when an impasse over the borrowing limit triggered the first-ever US credit downgrade and a 16% drop in the S&P 500 over the span of 10 days.

Just like in 2011, investors today are underestimating the dysfunction in Congress, said Wadhwani. President Joe Biden and congressional Republicans made little tangible progress Tuesday toward averting a default, but pledged negotiations on spending that would open the door to a possible agreement.

“I encounter quite a lot of investors with longer-term horizons who believe that any market reaction, any downdraft in equities, will be bought very quickly,” Wadhwani said. “In 2011 there were lots of people who believed that too and were suddenly shocked.” 

Before starting his fund in 2002, Wadhwani served on the Bank of England’s Monetary Policy Committee between 1999 and 2002. Last year, he was also tapped to serve on Hunt’s Economic Advisory Council. 

After revamping his quant model in 2020 in response to the pandemic and government stimulus, the CIO says he’s once again had to adjust. His portfolio risk is now running at lower levels than normal in preparation for the “treacherous” latter stages of a tightening cycle. 

The standoff has driven the steepest inversion between rates on short-term Treasury bills and 10-year notes in at least three decades, amid the risk of a potential default, the onset of recession and spiraling problems among US regional lenders. They are scenarios that could tighten financial conditions to such an extent the Federal Reserve is forced to dramatically reverse its own policy of the past year.

Bond markets “are pricing in some sort of event with a 20-30% chance which requires the Fed to move very aggressively by cutting 200 or 300 basis points,” Wadhwani said. “We shouldn’t discount these possibilities.”

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