Debt Ceiling Deal... Or No Deal
Summary
- The U.S. is once again coming up against its debt limit and the prospect of a default.
- While consensus expectation is that we’ll see a last-minute deal to avoid breaching the limit, we consider potential market outcomes - from most to least likely scenarios.
- A protracted period of debate or default could begin to damage the standing of the U.S. in global markets.
bauhaus1000
By Joshua Kutin, Head of Asset Allocation, North America; Edward Al-Hussainy, Senior Currency and Rates Analyst, Head of Emerging Market Fixed Income Research
Potential market outcomes — from most to least likely scenarios.
The U.S. is once again coming up against its debt limit and the prospect of a default. While consensus expectation is that we’ll see a last-minute deal to avoid breaching the limit, we consider potential market outcomes — from most to least likely scenarios.
A protracted period of debate or default could begin to damage the standing of the U.S. in global markets, impacting the standing of the U.S. dollar as a reserve currency and the relative appeal of the U.S. versus international equity markets.
There’s also impact for the real economy. In a protracted technical default, the government will need to balance the budget, leading to a cut in spending equal to the size of the deficit (currently 5.3% of GDP*). This would result in a deep recession.
Other creative solutions have been floated, including minting a $1 trillion coin to be deposited at the Fed and then using the proceeds for payments, liquidating non-marketable securities from government pensions, and issuing premium bonds. We believe these are unlikely.
The bottom line
The base case scenario is that an agreement is reached — likely at the last minute — and we still expect higher volatility as rhetoric heats up. In 2011, the rating of U.S. debt was downgraded due to debt ceiling brinkmanship. There could be longer-term implications once again, especially if the rest of the world grows tired of our repeated debt ceiling crises.
*Congressional Budget Office
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