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The deadlines! arm me! Threat of default!
The US may be a few days away from being unable to pay its bills, but Wall Street has seen this movie before, and markets seem unfazed – for now.
“One staffer on Capitol Hill likened this, the debt ceiling, to passing a kidney stone,” says Libby Cantrell, head of public policy at Pimco, which manages some of the largest bond funds in the world. “We all know it will pass. It’s just a matter of how painful it is.”
On Wall Street, everyone acknowledges that a debt default would be devastating to markets and the economy, and most investors believe that lawmakers will eventually cut a deal as they have in the past.
“We think the stakes are too high for both sides of the aisle to really reconcile,” says Eric Friedman, chief investment officer at US Bank Asset Management Group.
However, portfolio managers are still juggling what would happen if lawmakers are unable to pass a deal to raise or suspend the debt ceiling.
If so, the impact will be severe. Here’s what to expect.
How bad would that be?
At the very least, there will be a massive sell-off on Wall Street. In its latest analysis, UBS says the S&P 500 could drop at least 20%.
But it is hard to predict how much worse the US could get because the US has not defaulted on its debt.
Analysts believe the sell-off could match or exceed the sharp drop in September 2008, when the House of Representatives rejected a $700 billion bailout package while the United States was on the brink of the global financial crisis.
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The Dow Jones Industrial Average fell about 778 points that day, which was then the largest single-day drop in points in the index’s history.
A default would send US bond markets sharply lower.
Treasurys are among the safest investments all over the world. They are held by companies and countries around the world and used as collateral in all kinds of financial transactions. If the federal government fails to pay bondholders, it will have unimaginable consequences for the standing of the United States
A default could also weaken the US dollar, which is widely seen as the most important currency in the world due to the crucial role it plays in the global economy.
“The world’s main reserve currency and the world’s ‘safe’ asset, which form the bedrock of the global financial system, have suddenly become much less safe and must be re-priced,” UBS economists wrote in a May 19 note to clients. “It is unpredictable how this will cascade through the system.”
Analysts also believe that credit rating agencies will downgrade the country’s credit rating.
Currently, the United States has an “AAA” rating from two of the three major credit agencies. The US suffered a credit downgrade in 2011 from another major ratings firm, when S&P Global Ratings downgraded the country to AA+ amid another round of debt negotiations under President Obama.
How will market turmoil affect me?
Obviously, a sharp decline in stocks will hurt pension funds or other investment funds across the board. At the same time, bond markets determine all kinds of borrowing costs, which would rise sharply if there were a US default.
This could be worse news for anyone hoping to buy a home or a car at a time when borrowing costs are already skyrocketing after the Federal Reserve aggressively raised interest rates to fight soaring inflation. Mortgage rates, for example, will go up even more, and so will credit card interest rates.
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Inflation has eased somewhat, but it’s still close to the Fed’s 2% target, and many economists predict the US is heading into a recession. Moreover, there is still turmoil in the banking sector after the recent failures of three regional lenders.
“There is already a lot of pressure on the US economy,” says Seema Shah, chief global investment analyst at Principal Global Investments. “She can’t afford another big shock to fall on her head.”
Echoing what policymakers have said, Shah said that a government default would not only trigger a domestic recession, but could lead to another global financial crisis.
Is this how it will be?
As long as the United States has that limit on how much it can borrow, that is more likely to happen.
Lawmakers have voted to raise the debt ceiling more than 100 times, but debates over the debt limit have become more divided and used as a political weapon.
In recent days, business leaders have become more involved in the process.
On Thursday, Treasury Secretary Janet Yellen met with dozens of bank CEOs, while more than 100 CEOs wrote a letter to President Biden and congressional leaders, warning them of the consequences of inaction and encouraging them to raise the debt limit.
“Action to end the outstanding debt crisis is now necessary,” they wrote, noting that a default would “weaken our standing in the global financial system.”
“We strongly urge that an agreement be reached quickly so that the country can avoid this potentially devastating scenario.
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