Clipped from: https://www.financialexpress.com/investing-abroad/featured-stories/what-a-us-debt-ceiling-standoff-could-mean-for-markets/3022610/
If lawmakers cannot reach an agreement, there may be a significant impact on the U.S. economy and markets.
The root of the problem is the $31.4 trillion federal debt ceiling — the limit above which the U.S. cannot technically issue any new debt.
By Michael Zezas
The U.S. Treasury may be on a path to defaulting on its debt and delaying key benefit payments such as military salaries, tax refunds, food stamps and unemployment insurance. If lawmakers cannot reach an agreement, there may be a significant impact on the U.S. economy and markets, including a possible downgrade in U.S. credit worthiness.
The root of the problem is the $31.4 trillion federal debt ceiling — the limit above which the U.S. cannot technically issue any new debt. There are two key ways in which the standoff, and certainly a default, could hurt markets and the economy. One relates to U.S. Treasuries, the other to consumer spending.
Unless Congress increases the debt limit, the government cannot borrow money or issue bonds to pay its bills. In previous years when the government has hit this limit, different political parties have used the standoff as leverage to force policy changes. In the last decade alone, negotiations have gone down to wire several times.
In this instance, Republicans are seeking a cut in government spending in exchange for raising the debt limit. Democrats want a no-strings-attached, or “clean,” increase.
In the interim, the Treasury has announced a debt-issuance suspension period, during which it can take extraordinary measures, such as suspending investments in various retirement plans for government employees. But a true resolution is likely to be at least four months away, and investors should prepare for a rough road to any agreement.
The Congressional Budget Office projects that, if the debt limit remains unchanged, the government’s ability to borrow using extraordinary measures will be exhausted between July and September — the so-called X-date, when the potential for adverse market and economic impacts spikes sharply.
Morgan Stanley analysts estimate the X-date will be early August. There are a range of possible outcomes with increasing degrees of risk, based on the ways in which austerity and resolution come into play before or after the X-date.
The least risky scenario for the economy and markets sees a deal reached before the X-date with no austerity measures, thus avoiding a default and the kind of spending cuts that could hamper economic growth in the near term.
At the other end of the spectrum, the riskiest involves a deal after the X-date, combined with austerity measures in an effort to trim government spending. This route would cause lasting market and economic harm to U.S. growth. The actual outcome could be anywhere along the spectrum between these two possibilities.
Despite the risk, an early compromise looks unlikely without some kind of catalyst to prod one or both sides. While the fear of a default’s political and/or economic repercussions could provide that incentive, Congress still might not be sufficiently motivated until the X-date is very near or has passed.
(Author is Managing Director, Head of U.S. Public Policy Research & Municipal Credit Strategy, Morgan Stanley)