Debt ceiling unnerves markets
“A default on US obligations would produce an economic and financial catastrophe,” says US Treasury secretary Janet Yellen. On Tuesday US president Joe Biden and Republican congressional leaders made modest progress towards a deal to raise the country’s $31.4trn debt ceiling, the legal public-borrowing limit. However, the two sides remain far apart. Without a deal the US government could default on its bonds, a benchmark safe-haven asset for global financial markets, as soon as 1 June. Aside from one accidental late payment caused by a technical glitch in 1979 the US has not defaulted on its debts in modern history. Republicans want “budget cuts” and “tougher work requirements on government aid recipients” in return for allowing the federal government to issue new bonds, says Bernd Debusmann on the BBC. Democrats are worried that such moves could unpick president Biden’s previous legislative achievements.
A tail risk for markets
America actually hit the debt ceiling in January, with the Treasury resorting to cash reserves and accounting workarounds to keep the money flowing since then. Those measures will soon be exhausted, a day ominously known as the “X-date”. That would leave the government unable to “pay the salaries of federal and military employees” or to meet interest payments on existing bonds. The debt-ceiling showdown has “yet to cause much disruption to financial markets”, says Joe Rennison in The New York Times. Most investors are assuming that a deal will be done eventually, but if things go down to the wire they could start to panic. During the 2011 debt-ceiling fight the S&P 500 blithely rose through July, only to plunge by 17% in weeks as credit-ratings agency S&P downgraded America’s rating.
Given America’s deep political divisions, investors shouldn’t necessarily bet that “cool heads will prevail”, says Katie Martin in the Financial Times. Political analyst Tina Fordham tells CNBC that there is “a roughly 20% chance of a US debt default in the coming weeks… 20% probability events happen all the time”. Yet financial markets are struggling to price the risks: “just as it is not possible to be a little bit pregnant, it is hard to price in a little bit of default”, say Richard McGuire and Lyn Graham-Taylor of Rabobank. Signs of stress have so far been limited to rising prices for US creditdefault swaps, instruments that offer “a kind of insurance against non-payment of debt”.
Indeed, as John Authers points out on Bloomberg, it is currently more expensive to insure against a US sovereign default over the next year than a default by “Mexico, Greece... South Africa” or “Colombia”. Whatever the outcome, it is “difficult to see any good reason for enthusiasm about US assets from this sorry saga”.