Wall Street banks including JPMorgan and Goldman Sachs are warning that Washington is heading for the riskiest debt ceiling confrontation since 2011, when the US lost its risk-free credit rating.
The fight over the debt ceiling could be the most important issue facing the US economy in 2023, according to a JPMorgan note to clients on Friday.
Congress has had many tussles over the lifting of its borrowing limit in recent years and has never defaulted on its debt. But given the particularly fractious state of the legislative body, a deal to stop the world’s biggest economy from defaulting on its debt may be harder to seal this time, said JPMorgan’s chief US economist Michael Feroli.
The implications of a default were hard to predict, added Feroli, but could plausibly result in a “severe recession”.
“Even the best case will probably see the sort of brinkmanship that occurred in the 2011 debt ceiling crisis,” he said.
The US Treasury bond market is the bedrock of the global financial system and a haven for central banks and investors globally. A debt default would in all likelihood have cascading implications across multiple asset classes and geographies.
The government last week started taking “extraordinary measures” to meet its obligations after the country hit its $31.4tn borrowing limit. The Republican majority in the House of Representatives has demanded deep budget cuts in exchange for raising the debt ceiling. The White House and Democratic majority in the Senate say that is not an option.
In recent decades, the debt ceiling has regularly devolved into a partisan battle in Washington when government is divided. But some pundits think the looming showdown will be particularly difficult to resolve because Republican House speaker Kevin McCarthy secured election in part by promising to play hardball with Democrats.
McCarthy was elected following 15 rounds of voting after a hardline minority refused to back his speakership, suggesting a fractured Republican caucus that may be unwilling to vote for a deal even if a compromise is reached.
“We have the most risk of debt limit problems since 2011,” said Alec Phillips, Goldman Sachs’ chief political economist, adding that this time round the US has more debt and higher interest rates.
Pablo Villanueva, senior US economist at UBS, said “this is a bit of a different debt ceiling episode” because the Fed is engaged in quantitative tightening and “very rapidly” removing cash from the economy after years of monetary stimulus.
“That’s why I think the debt ceiling is particularly important this time around,” he added.
For now, US government and corporate bonds have started the year on an upbeat note, buoyed by signs of easing inflation and hopes the Fed will soften its stated intention of continuing to ratchet up interest rates.
However, some market participants warn that investors are not pricing in the high-stakes confrontation, with many anticipating that Congress will capitulate.
“In the past Congress has acted before the ‘X’ date,” said Villanueva. “So I think the market is assigning a very high probability of Congress acting again.”
Meghan Graper, global co-head of investment grade syndicate at Barclays, said: “The debt ceiling is not impacting our market now. But I’d expect any implications to be a second-half phenomenon.”
Maureen O’Connor, global head of high-grade debt syndicate at Wells Fargo, said: “The debt ceiling this year smacks a little different than some of the debt ceiling drama we’ve dealt with in the last couple of years.
“When we talk about Black Swan events, this is one of those,” she added.
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