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 debt ceiling fight could be the top concern for the US economy in 2023, according to a JPMorgan client note on Friday.
Congress has had many arguments over the past few years over lifting its credit limit and has never defaulted on its debt. But amid the particularly strained state of affairs in the legislature, sealing a deal to save the world’s largest economy from defaulting could be more difficult this time, said JPMorgan’s chief US economist Michael Feroli.
The impact of a default is difficult to predict, Feroli added, but could plausibly result in a “severe recession.”
“Even in the best-case scenario, the kind of brinkmanship that occurred in the 2011 debt ceiling crisis is likely to occur,” he said.
The US Treasury market is the bedrock of the global financial system and a paradise for central banks and investors worldwide. A debt default would likely have cascading effects across multiple asset classes and regions.
The government last week began taking “extraordinary measures” to meet its commitments after the country hit its $31.4 trillion credit limit. The Republican majority in the House of Representatives has called for deep budget cuts in return for raising the debt ceiling. The White House and the Democratic majority in the Senate say that’s not an option.
In recent decades, the debt ceiling has regularly turned into partisan warfare in Washington whenever the government is divided. But some pundits believe the upcoming showdown will be particularly difficult to resolve, as Republican House Speaker Kevin McCarthy secured the election in part by promising to play tough with Democrats.
McCarthy was elected after 15 rounds of voting after an uncompromising minority refused to support his speakership, indicating a fragmented Republican faction that may be unwilling to vote for an agreement even if a compromise is reached.
“We have the greatest risk of debt ceiling problems since 2011,” said Alec Phillips, chief economist at Goldman Sachs, adding that this time the US has more debt and higher interest rates.
Pablo Villanueva, senior US economist at UBS, said “this is a slightly different episode of the debt ceiling” as the Fed is conducting quantitative tightening after years of monetary stimulus and removing cash from the economy “very quickly”.
“So I think the debt ceiling is particularly important this time,” he added.
US Treasury and corporate bonds have started the year on an upbeat note for the time being, buoyed by signs of slowing inflation and hopes that the Fed will soften its stated intention to raise interest rates further.
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However, some market participants warn that investors are not pricing in the high-stakes confrontation as many expect Congress to capitulate.
“Historically, Congress has acted before the ‘X’ date,” Villanueva said. “So I think the market is assigning a very high probability that Congress will act again.”
Meghan Graper, global co-head of investment grade syndicate at Barclays, said: “The debt ceiling is not impacting our market at this time. But I would expect any impact to be a second half phenomenon.
Maureen O’Connor, Global Head of High-Grade Debt Syndicate at Wells Fargo, said: “This year’s debt ceiling sounds a little different than some of the debt ceiling dramas we’ve been dealing with in recent years.
“If we talk about Black Swan events, this is one of them,” she added.