Debt crisis casts shadow over US financial markets

A default would devastate the US financial markets, but even if the debt ceiling is raised in time, there is no guarantee that everything will be fine, according to Politico.

This week, the US Treasury Department reiterated that the government may not be able to pay its debts due after June 1 if Congress does not approve an increase in the debt ceiling.

Last month, the Republican-controlled House of Representatives passed a bill that would raise the debt ceiling on the condition that the government make deep spending cuts. But the White House has rejected the terms, with Biden officials arguing that the bill would strain the economy and cost jobs.

But observers say the White House may now agree to curb some spending in exchange for concessions from Republicans as the “X-date” — the time when the Treasury runs out of money — approaches. Financial markets are also facing significant volatility due to rising interest rates and growing discontent with the economy.

Mike Reynolds, vice president of investment strategy at Glenmede, agreed that the White House would likely accept spending cuts to reach a deal. But the result could be “some volatility” in the stock market.

Jenny Johnson, president and CEO of mutual fund Franklin Templeton, said she was not sure exactly how financial markets would react. But she admitted she was frustrated by the series of adverse events over the past several months.

“It’s a shame as a nation that we’ve come to this,” she said. While she believes policymakers will reach a deal to raise the debt ceiling in time and the U.S. will continue to dominate financial markets, she said the repeated crises are “damaging” investor confidence.

The facade of the New York Stock Exchange. Photo: AP

Historically, U.S. stocks have been on fire the last time the U.S. was on the brink of default. In 2011, with less than a week to go until X-date, major indexes fell 20%. This time, Moody's Analytics estimates that stock prices could fall by about 20%.

The current economic climate is a difficult place for Biden and Republicans to negotiate. It also risks eroding public confidence in the White House’s ability to manage the economy.

After a wave of bankruptcies at several regional banks, community and midsize financial institutions are starting to pull back from the credit markets. Consumer confidence is waning. And even as Americans continue to shop, big-box retailers and credit card data point to a trend toward belt-tightening.

Meanwhile, persistent inflation has prompted the Federal Reserve to signal that it is unlikely to cut interest rates until it is confident that the price surge has been contained. The potential for an economic slowdown will also influence how financial markets perceive any deal that Biden and McCarthy strike.

While the Republican debt ceiling bill promises energy licensing reforms and other market-boosting changes, it also includes big spending cuts that could spook financial traders if the economy takes a turn for the worse.

That's what happened in 2011, after President Barack Obama and Republicans announced a deal just two days before X-Date. "It's almost paradoxical, but the S&P 500 fell after the new debt ceiling was passed in 2011," Reynolds said.

Two days after Obama signed the new debt ceiling bill, the U.S. stock market suffered its biggest drop since the financial crisis, as investors worried that the spending cuts in exchange for a deal would hurt an economy still mired in turmoil.

On August 5, 2011, S&P announced a historic decision to downgrade U.S. government bonds, sending the stock market even lower. Major market indexes did not recover until the following year, 2012.

So even if Congress and the White House reach an agreement on a new debt ceiling by June 1, there is still a chance that US government bonds will be downgraded. Richard Bernstein, CEO of Richard Bernstein Advisors and former chief investment strategist at Merrill Lynch, believes the possibility of a downgrade is 50%.

"We are just two weeks away from X-date. We must raise the debt ceiling now and avoid economic disaster," said Rep. Brendan Boyle, the top Democrat on the House Budget Committee.

But there is still confidence in the ability to weather this debt-ceiling storm. The Wall Street Journal notes that the US economy is much more resilient than it was after the global financial crisis. The unemployment rate is a fraction of what it was in 2011. Households and businesses were flush with cash when the Fed began raising interest rates last year, giving them a cushion to withstand losses from higher interest rates.

Even if Republicans convince the White House to cut spending, they could change their stance if a recession hits the states they control, according to Joe Brusuelas, chief economist at RSM US.

Even if the new spending limits are binding, the way the White House and Congress are currently negotiating suggests that any limits that are put in place would not be tied to the needs that arise during a recession, Joe said.

Phien An ( according to Politico, WSJ )

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