Explainer: Investors are starting to worry about the U.S. debt ceiling fight that is coming up.
Another fight over the debt ceiling is coming up in the US, giving investors one more reason to worry about markets this year.
The United States will probably reach its legal limit of $31.4 trillion in borrowing on Thursday. This means that the Treasury will have to take unusual steps to manage cash, which will likely put off a debt default until early June.
In the last ten years, lawmakers have often been at odds over the debt limit, but most of these fights have been settled before they could affect the markets. It wasn’t always like that, though: Standard & Poor’s lowered the U.S. credit rating for the first time in 2011 because of a long standoff, which shook the financial markets.
Some investors now worry that the narrow majority of the Republican party in Congress could make it harder to find a solution this time.
Here are some questions and answers about the effects on markets:
What is the limit on debt?
The debt ceiling is the most money that the government of the United States can borrow to pay its bills. When the limit is reached, the Treasury can’t make any more bills, bonds, or notes. Tax money is the only way it can pay its bills. At the moment, the ceiling is about the same as the country’s annual economic output.
The U.S. government is getting close to its debt limit again.
When will the United States reach the debt ceiling?
Janet Yellen, who is in charge of the U.S. Treasury, said last week that the government could only pay its bills until early June if the limit wasn’t raised. Some analysts thought that the government would run out of money and be unable to borrow any more by the so-called “X date,” which was sometime in the third or fourth quarter.
The “drop-dead date,” according to Jonathan Cohn, Head of Rates Trading Strategy at Credit Suisse in New York, is between September and early November. Goldman Sachs (NYSE:GS) thought that the debt ceiling would be reached between August and October.
What can the Treasury do to fulfil its duties?
Once the debt limit is reached, it can use cash it already has and take other steps to make money. As of Jan. 13, it had a balance of $321,500,000,000 in the Treasury General Account (TGA). Yellen said that the Treasury plans to stop putting money into two funds for government retirees and a part of a savings plan for federal employees this month.
Graphic: The operating cash balance of the U.S. Treasury https://fingfx.thomsonreuters.com/gfx/mkt/akveqajgyvr/Cash%20balance.png
DO BOND PRICES REFLECT DEFAULT RISKS IN THE US?
Some Treasury bills that mature in the second half of the year already have higher yields than bills that mature in the first half. Some analysts think this is because there is a higher chance of default in the second half.
Curve of the U.S. Treasury bill for 2023: https://www.reuters.com/graphics/USA-CONGRESS/DEBT/lbvggogmavq/chart_eikon.jpg
The cost of insuring U.S. debt against default for five years was about 32 basis points on Tuesday, which was the highest spread since 2013.
In the United States, credit default swaps are available at https://fingfx.thomsonreuters.com/gfx/mkt/myvmogqmovr/US% 20-year%20single% 20name%20credit%20default%20swap.png
“The Treasury curve is pricing in some kind of distortion in the third and fourth quarters,” said Eric Theoret, a global macro strategist at Manulife Investment Management. “This is consistent with the fact that the government has run out of stop-gap measures it can use right now to run down cash balances at the Treasury in order to fund the government.”
Andrew Hunter, a senior U.S. economist at Capital Economics, thinks that the risk of a crisis will make the yields on Treasury bills and bonds due this summer go up in the coming months.
What happens if the United States defaults?
Some investors might move their money into international stocks and bonds from other countries if the chance of a default goes up.
In 2011, a fight in Washington over the debt ceiling led to a drop in stock prices and brought the U.S. close to default. As a result, Standard & Poor’s took away the U.S.’s top-tier AAA credit rating.
In a research note, Goldman Sachs said that the S&P 500 fell 15% during the 2011 crisis, and stocks with the most sales tied to U.S. government spending fell by 25%.
Concerns grew in 2021 as Congress faced deadlines to fund the government and deal with the debt ceiling. Weakness in the stock market and the strange pricing of short-term Treasury bills showed this.
If the U.S. actually stopped paying its debts, it would probably send shockwaves through the world’s financial markets. This is because investors would lose faith in the U.S.’s ability to pay its bonds, which are seen as some of the safest investments and are used to build the world’s financial system.
David Kelly, the chief global strategist at J.P. Morgan Asset Management, said that this “could leave some lasting scars, such as a permanent rise in the cost of funding U.S. federal debt.”