It may take a market mishap to end a debt ceiling standoff that threatens to trigger a previously unthinkable US Treasury default.
“Now, an interesting question is whether financial market vigilantes could flex their muscles in bonds, stocks or even currencies the closer the government runs out of cash,” said Steven Barrow, head of G-10 strategy at Standard Bank, in a note late last week.
US Treasury Secretary Janet Yellen warned on Monday that the US government could exhaust its solvency as early as June 1 if the debt ceiling is not lifted. The government technically bumped into the $31.4 trillion borrowing limit earlier this year, but has employed accounting maneuvers that have allowed it to continue to make payments to bondholders and others.
See: Why Debt Ceiling Showdown is a ‘Catch-22’ for Markets After House Passes Law
Late Monday, President Joe Biden invited House Speaker Kevin McCarthy, R-California, and other congressional leaders to the White House for a May 9 meeting.
McCarthy and congressional Republicans want spending cuts in exchange for raising the borrowing limit, while the Biden administration insists it be raised unconditionally. The Republican-controlled House of Representatives narrowly passed a bill last week that would raise the debt limit, but the legislation is viewed as a non-starter in the Democrat-controlled Senate.
Read: Debt ceiling bill is set to receive Senate hearings, but a vote is not expected
Disappointing tax receipts in April brought forward the so-called X-date when the Treasury would run out of special maneuvers that would allow it to continue all of its payments. Analysts fear an early June deadline could prove impossible.
“There is no chance — none — that the budget agreement passed by the House of Representatives could win a passage in the Senate, where senior Republicans are reluctant to interfere,” said Greg Valliere, chief US policy strategist at AGF Investments, in a statement Tuesday. “In the House of Representatives, a few dozen hardliners have no interest in raising the debt ceiling if the Senate changes their bill.”
So what would it take?
“It’s simple – a stock market crash or signs of a looming recession. Without a catalyst, Congress will continue to tremble and stand its ground. Are the markets fearing a default? Apparently not yet, but that could change by Memorial Day,” Valliere said.
The stock market has largely dismissed the issue so far. Major indices posted gains in April. The S&P 500
SPX
is up nearly 9% year-to-date, while the Dow Jones Industrial Average
DJIA
is up over 2% and the Nasdaq Composite
COMP
has increased by almost 17%.
US stocks opened slightly lower on Tuesday morning.
The impasse on the debt ceiling has rattled corners of the government bond market and triggered volatility in the short-dated Treasury bill market as investors avoid debt that could be affected by a potential default. The cost of insuring US government debt against default using financial instruments known as credit default swaps has risen to a high in more than a decade.
Opinion: How dangerous is Washington’s debt ceiling standoff? Enough that US debt is now seen as riskier than Portugal’s.
Would the stock market chaos do the job?
There is a precedent. The Dow plunged over 700 points in a single session in late September 2008, a move that was then the largest point decline on record and a fall of more than 7% after the House of Representatives passed legislation introducing the $700 billion -Dollar Trouble Asset Relief Program, or TARP, after the collapse of Lehman Brothers.
Analysts argue that the market panic helped consolidate support for the controversial law, which was subsequently passed and signed into law by President George W. Bush in early October. (Of course, not everyone agrees that the price slide was the deciding factor.)
The question now is whether market participants will blink as the standoff stretches to the end, Barrow wrote.
He anticipates some build-up of pressure in the form of weaker stocks, higher returns on short-term assets that might not be paid out, and a weaker US dollar, but the moves wouldn’t match what would happen in the event of a technical failure — or even a scenario where a technical failure is averted, but rating firms drag the US down another notch, as they did in 2011.
But policymakers should learn from the Silicon Valley bank collapse in March, which came after customers withdrew deposits at an unprecedented rate, demonstrating the interconnectedness of the financial system in the digital age.
“Certainly this must be a warning that when it comes to the debt ceiling, if there is a run on the US before or after X-Day, it could be much quicker and likely much deeper than we’ve seen before,” wrote Barrow. “In short, the stakes appear to be much higher and investors just have to hope that politicians will appreciate that.”
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