Congress and the White House are rushing toward a June 1 deadline to resolve a debt ceiling debate, with all of America’s faith and credit at stake.
Treasury Secretary Janet Yellen has said that failing to lift or suspend the debt ceiling would lead to «economic and financial catastrophe,» dimming the US economic outlook already clouded by high inflation, high interest rates, interest and concern in the banking industry.
The Congressional Budget Office and Treasury projected on May 3 that if the government doesn’t pay its bills for even a week, 500,000 Americans would lose their jobs as the economy shrinks 0.6%.
What is the worst case?
A «prolonged» default, lasting more than three months, would trigger a Great Recession-like scenario in which up to 8.3 million people could lose their jobs. In this scenario, the stock market could fall 45%, hurting the accounts of those who save for retirement.
Those still working would be pressured by even higher interest rates. Mortgage rates, for example, could rise further after rising from around 3% in December 2021 to 6.4% this month.
Economists say those scenarios loom large in a US that is already at risk of recession. Deutsche Bank projects a recession to begin later this year as a result of the Federal Reserve’s efforts to raise interest rates and deliberately slow an economy plagued by high inflation.
Even though unemployment is at a record low of 3.4%, high inflation is outpacing wage gains. Americans have had to tap into their savings to make ends meet. households saved a total of $1.6 trillion before the pandemic, but now they have just $1 trillion in savings.
Credit card rates, nearly 24% according to LendingTree, loom over $986 billion in credit card balancessurpassing the pre-pandemic high by $59 billion.
In addition to high borrowing costs and concerns that the job market will change course soon, The Conference Board’s measure of consumer expectations it is at levels «associated with a recession within the next year.»
‘A bigger problem’
A debt-ceiling debacle would only worsen that outlook, economists say.
“If you were to slide off this cliff and the government technically defaulted, that would be a big problem. It would cause a global crisis,” Deutsche Bank US senior economist Brett Ryan said of a possible default.
The debt ceiling is a legal limit on the amount of debt the US Treasury can issue. The government exceeded that limit on January 19, after which it scrambled to find cash elsewhere to keep the lights on. The Treasury estimates it will exhaust those «extraordinary measures» on June 1, a date that could change depending on factors that are hard to predict, such as tax payments as of last month’s filing deadline.
After June 1, the government would risk defaulting or defaulting on its debt payments.
“We would be in uncharted territory, and the consequences for the US economy would be very uncertain and could be quite adverse,” the country’s top economic policy maker, the Federal Reserve Chairman, said on May 4. Jerome Powell.
Failure to pay the bills would erode confidence in US government debt, seen to date as largely «risk free» due to the nation’s record of paying its debts on time and in full. A default could lead to a dramatic drop in the value of US government bills, notes and bonds (thus increasing the «yield» your coupons pay as a percentage of their value).
How important is that performance?
Almost every corner of the financial world relies on US government returns as a benchmark. Domestic and foreign investors closely watch returns when trading securities.
Mortgage lenders look at US Treasury bonds when deciding what rates to charge you when buying a home. Third Way estimates that a breach could add $130,000 to the cost of an average 30-year mortgage.
The US may not even have to technically default to realize some of these effects. In 2011, the S&P credit rating agency downgraded the nation’s prized AAA rating due to the “political brinkmanship” of its debt ceiling deliberations. The downgrade, which was never reversed, increased government borrowing costs by an estimated $1.3 billion.
There are particular corners of the US financial system at risk now, which would make any negative debt ceiling outcome particularly pronounced in 2023. Rising government bond yields could worsen the outlook for real estate business, where teleworking arrangements are squeeze debt-laden homeowners at rising interest rates.
Banking concerns add to the pressure
The failures of three of the top 30 US banks in the past two months add to the risks. The collapse of First Republic Bank on May 1 reignited concerns about the ability of regional banks to survive higher interest rates, a conundrum that could worsen if a debt-ceiling deadlock further pushes US government yields. which in turn raises interest rates further.
Furthermore, economists worry that the political air is not there to respond quickly to any acceleration of the banking system’s problems, if necessary.
“Complicating any future debate on a government bailout is a showdown threat over the debt ceiling,” Wells Fargo Investment Institute strategists Gary Schlossberg and Jennifer Timmerman wrote on April 25.
and also politics
Goldman Sachs Economics noted on May 1 that the GOP is also factoring in the 2024 election in any debt-ceiling strategy, as it «presents the best opportunity for congressional Republicans to win any political concessions from the president.»
Although it is a mechanism to limit government borrowing, the debt ceiling does not limit spending. The federal budget process, separate from the debt ceiling, determines how much money the government spends and where it is spent. Still, House Speaker Kevin McCarthy and President Joe Biden continue to disagree on how to link the two.
McCarthy is trying to combine a debt limit hike with spending cuts, but Senate and White House Democrats are adamant on a «clean» bill that would raise the debt ceiling, leaving debates on spending for the annual budget process separately. .
Despite the stalemate, history is on the side of resolution. Since 1960, Congress has moved 78 different times increase or extend the borrowing limit.
Brett Ryan of Deutsche Bank said he hopes Congress will pass a short-term extension that would leave the debt ceiling debate until late September, when the economy may already be weak.
“It just increases the odds of a recession,” Ryan said.