US Debt Ceiling FAQ
- The US debt situation is once again under the spotlight, given the looming x-date in early June
- Negotiations over the debt ceiling has become contentious under a divided Congress
- Biden, GOP have reached an in-principle agreement but Congress must approve to avert a US default
- We maintain our base case that US Congress would not stand idly by
- With heightened volatility expected over this issue, investors should keep a posture of prudence
Markets have largely shrugged off the possibility of the US defaulting on its debt, and Washington has finally made significant progress on its debt ceiling bill with an in-principle agreement between President Biden and House Speaker Kevin McCarthy to raise the debt ceiling. Nonetheless, it remains alarming that Congress has mere days left to approve a deal to avert a US default (projected to take place by 5 June), that could have calamitous effects on the global economy.
For easy reference, here is a list of questions and answers regarding the US debt ceiling issue, along with some recent developments.1. What is the debt ceiling?
The debt ceiling was created by Congress in 1917, to set a maximum of outstanding debt the US government can incur.2. Why has the debt ceiling been in focus of late?
The debt ceiling was reached in January 2023 when the total national debt hit USD31.4t. In response, the Treasury invoked “extraordinary measures” to continue operating. In May 2023, Treasury Secretary Janet Yellen warned that these measures could be exhausted by early June 2023 (the x-date). Given our proximity to the x-date, Congress must now vote to suspend or raise the debt ceiling or risk a US default.3. What is the “x-date”?
The x-date refers to the point where the US government’s funds are no longer sufficient to meet its financial obligations. Most current estimates are for early June, but it is not possible to gauge the exact date.4. What happens if an agreement is not reached by the x-date? / What are the consequences of a US default?
- Higher borrowing costs: US Treasuries have long been viewed as risk-free assets, keeping their rates very low. A default would cause borrowing costs – including credit card, car loans and mortgage rates – to spike because US debt serves as a critical benchmark for various forms of credit.
- Risk-asset price fragility: Higher risk-free rates will inflate discount rates, which are used to value assets. Steeper discount rates will compress valuation across asset classes, hitting investor confidence.
- Delayed payments: Payment to millions of civil servants, social security beneficiaries etc. will be delayed indefinitely. Businesses and households will be unable to pay their bills while awaiting government receivables. This may lead to further tightening of liquidity and cause the economy to accelerate towards a recession.
- Broad financial instability: The belief that America’s government will pay its creditors on time underpins the smooth functioning of the global financial system. It makes the dollar the world’s reserve currency and US Treasury securities the bedrock of bond markets worldwide. A breach of the US debt ceiling would likely cause severe damage to global economies.
- No disorderly default – Noting the above repercussions (see point 4), we believe that it is not in the interest of either side of congress to allow a disorderly default. There is a high likelihood that Congress will approve a raised debt ceiling (see point 6), even if it just barely before the x-date.
- Greater fiscal prudence to alleviate the need for further monetary tightening – Greater fiscal prudence of the US in managing its ballooning debt would (a) ease inflationary pressure, and (b) tighten consumer confidence in the medium term. This implies that the Fed need not hike much further as credit conditions would already tighten in response to such spending cuts.
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