Debt Ceiling 2.0
Recap
A few months ago, we featured a blog on the debt ceiling. To recap, the debt ceiling is a cap on the amount of new debt that the Treasury Department can issue to meet its obligations – that is, money that has already been spent or appropriated.
On January 19, the U.S. nation debt topped the $31.4 trillion threshold set by Congress and Treasury Secretary Yellen notified Congress that a series of “extraordinary measures” would be undertaken to keep the U.S. from defaulting, thus pushing out the “x-date” (the date on which the U.S. would no longer be able to meet all its financial obligations) to sometime in June.
Where Are We Now?
Currently, House Speaker Kevin McCarthy and President Biden and representatives from their parties, are negotiating a consensus around a spending bill that could pass both the Republican-controlled House of Representatives and the Democrat-controlled Senate.
In short, Republicans are pushing for a one-year spending cap at 2022 levels – and, in part, more stringent work requirements for certain federal aid programs, such as SNAP (“Supplemental Nutrition Assistance Program”, better known as “food stamps”), TANF (“Temporary Assistance for Needy Families”), and Medicaid.
Democrats, meanwhile, largely want “clean” legislation – that is, a debt ceiling increase without conditions.
What Happens if the U.S. Defaults?
As the U.S. has never failed to raise the debt ceiling before and never officially defaulted, ascertaining the total impact of a default is partly speculative. However:
UBS says the S&P 500 could fall by at least 20%.
U.S. bond markets would also turn sharply lower.
U.S. dollar would weaken.
Interest rates would jump higher (on everything from mortgages, credit cards, auto loans, etc.)
Federal payments, to include everything from payments for Social Security to members of the armed services, could be disrupted.
Medicare and Medicaid could be disrupted.
The question on recession and whether a “no landing”, “soft landing”, or “hard landing” would become decided as markets and investors would brace for a hard landing and the U.S. potentially slipping into a deep recession.
What are Markets Predicting?
Activity in the Credit Default Swap market (made famous in part by the 2008 financial crisis and movies like The Big Short) are currently pricing in a probability of a default in U.S. debt obligations (that is, negotiations prove fruitless with no resolution and no action is taken to avoid a default) of about 4%. This is about the probability markets were pricing in in 2013 and slightly higher than in 2011.
What Happens Next?
For the time being, markets are more concerned with lingering inflation, higher-for-longer interest rates, and the “hard” vs “soft” vs “no” landing scenarios regarding a recession.
While past performance is never an indicator of future results, the U.S. has a long track record of uninterrupted debt payments.
The last few years have been “unprecedented” enough without needing to pile on to that trend.
Sources
CBS Interactive. (2023, May 19). What happens if the U.S. defaults? how the debt ceiling could impact your money. CBS News. https://www.cbsnews.com/news/debt-ceiling-deadline-default-impact-on-your-money-social-security-mortgage/
The cds market’s view on US default. MSCI. (n.d.). https://www.msci.com/www/blog-posts/the-cds-market-s-view-on-us/03820087801
Gura, D. (2023, May 21). Here’s what could happen in markets if the U.S. defaults. hint: It won’t be pretty. NPR. https://www.npr.org/2023/05/21/1177203159/debt-limit-ceiling-default-wall-street-biden-mccarthy-economy
Rogers, K. (2023, May 10). How past debt limit crises shaped Biden’s no-negotiation stance. The New York Times. https://www.nytimes.com/2023/05/10/us/politics/biden-obama-debt-limit.html
Watson, K. (2023, May 18). Debt ceiling demands and red lines for the White House and Republicans. CBS News. https://www.cbsnews.com/news/debt-ceiling-demands-republicans-democrats/