Wall Street banks including JP Morgan and Goldman Sachs warn that Washington is heading for the most dangerous debt ceiling showdown since 2011, when the US lost its zero-risk credit rating.
The fight over the debt ceiling could be the most important issue facing the U.S. economy in 2023, according to JPMorgan’s note to clients on Friday.
Congress has had many struggles in recent years over lifting its borrowing ceiling and has never defaulted on its debt. But given the state of disarray in the legislative body, a deal to avoid a default on the world’s largest economy may be more difficult this time, said Michael Frawley, chief economist at JPMorgan.
Frawley added that the consequences of a default were difficult to predict, but that it could lead to a “severe recession.”
“Even the best-case scenario is likely to see the kind of marginalization that occurred in the debt ceiling crisis of 2011,” he said.
The US Treasury bond market is a cornerstone of the global financial system and a haven for central banks and investors worldwide. A debt default is likely to have cascading consequences across multiple asset classes and geographies.
The government last week launched extraordinary measures to meet its obligations after the country reached its $31.4 trillion debt ceiling. The Republican majority in the House of Representatives has demanded deep budget cuts in exchange for raising the debt ceiling. The White House and the Democratic majority in the Senate say that is not an option.
In recent decades, the debt ceiling has regularly become a partisan battle in Washington, when government is divided. But some experts think the showdown will be difficult to resolve in the future, since Republican House Speaker Kevin McCarthy secured the election in part by promising to play hardball with Democrats.
McCarthy was elected after 15 rounds of voting after a hard-line minority refused to support his presidency, suggesting a fractured Republican caucus that may be willing to vote for him even if a compromise is reached. There is no agreement.
“We have the highest risk of debt limit problems since 2011,” said Alec Phillips, chief policy economist at Goldman Sachs, adding that this time the U.S. has more debt and higher interest rates.
“It’s a different debt ceiling episode,” said Pablo Villanova, chief U.S. economist at UBS, as the Fed engages in modest tapering and “very rapid” removal of cash from the economy after years of monetary stimulus.
“That’s why I think the debt ceiling is particularly important this time,” he added.
Already, U.S. government and corporate bonds have started the year on a positive note, bolstered by signs of easing inflation and hopes that the Federal Reserve will scale back its stated intention to continue raising interest rates.
However, some market participants warn that investors are not pricing in the face of high risk, and many predict that Congress will capitulate.
“In the past, Congress has acted before the ‘X’ date. So I think the market is pricing in a very high probability that Congress will act again,” Villanova said.
“The debt ceiling is not impacting our market right now,” said Megan Gripper, global co-head of investment-grade syndicate at Barclays. But I expect any implications to be a second-half phenomenon.”
“This year’s debt ceiling is a little different than some of the debt ceiling drama we’ve had over the past two years,” said Maureen O’Connor, global head of high-grade debt syndication at Wells Fargo.
“When we talk about black swan events, this is one of those,” he added.