What will happen to the U.S. financial system if Congress fails to increase the debt ceiling?
The U.S. authorities formally reached its USD 31.4 trillion borrowing restrict on 19 January, though a sequence of “extraordinary measures” ought to enable the administration to muddle via till at the least June earlier than borrowing constraints chew. For now, monetary markets are sanguine; the S&P 500 inventory market index is up up to now this 12 months, and 10-year Treasury yields have been broadly steady. The U.S. has by no means deliberately defaulted on its debt, and historic standoffs over the debt restrict have all the time resulted in both the Republicans or the Democrats blinking finally.
However, the danger of a protracted Congressional stalemate seems increased this time due to the polarized political panorama. Republican House Speaker McCarthy was himself solely elected to the put up after 15 ballots amongst members of his social gathering, and promised harsh public spending cuts so as to safe the assist of far-right Republicans; the Democrats flatly reject such cuts.
If no settlement is reached to increase the debt ceiling, the authorities will be pressured to lower spending to match income as soon as the Treasury’s “extraordinary measures” run their course. With the Consensus amongst our panelists for a 2023 fiscal deficit of almost 5% of GDP, this may pull an enormous quantity of public expenditure from the financial system just about in a single day. A mixture of furloughing, deep Federal spending cuts, a public debt default, credit standing downgrades, inventory market falls and better rates of interest would probably ensue, with the influence magnified the longer the debt ceiling dispute stays unresolved.
There are steps the authorities might take to mitigate the harm. The authorities might try to prioritize sure expenditure, resembling making bond funds at the value of slashing departmental spending in an try to calm monetary markets. There has additionally been speak of the authorities depositing a newly-minted coin with the Fed in change for money, or swapping excellent bonds for brand spanking new “premium” ones with a far increased rate of interest. And the Federal Reserve would absolutely intervene in some kind or different; in the previous, Fed officers have floated the risk of shopping for defaulted Treasury bonds whereas promoting unaffected ones as an example.
However, none of the Treasury’s choices would fully avert the fallout from the debt ceiling binding, and the Fed can be loath to bail out the authorities due to issues over inflation and political independence. As such, for now, the financial system’s greatest hope of rising unscathed is that the extreme penalties of default finally focus politicians’ minds—earlier than it’s too late.
Insights from our Analyst Network
On the outlook, the EIU mentioned:
“We ultimately expect a deal to be reached to raise the debt ceiling, given the severe consequences of a US debt default. A last-minute compromise remains the most likely scenario, given the depth of partisan tensions in Congress. As a result, brinksmanship over the debt ceiling will increase economic uncertainty in the coming months and distract lawmakers, weakening government effectiveness.”
On Fed intervention, ING analysts mentioned:
“Federal Reserve printing could be employed as a safety net […], where politics makes a mistake, and the Fed steps in as a payer of last resort. The Fed could rationalise doing so as a means of protecting the system. It could certainly soften the impact and indeed could prevent a technical default in the first place. However, this would not be a structural solution. Moreover, it poses its own independent threat to the financial system as the US dollar is undermined by monetary financing of the national debt.”
