Will markets face “catastrophic” consequences when the debt ceiling deal expires this week?

Spark Global Limited reports:

As much as $28.5 trillion of U.S. debt is at risk of default if Congress fails to reach an agreement to raise the debt ceiling before Saturday, when a two-year deal to suspend the government’s borrowing limit expires. Five prominent economists weigh in on whether the expiration of the U.S. debt ceiling will have a big impact on markets.

Treasury Secretary Janet Yellen on Friday urged lawmakers to raise or suspend the NATION’s debt ceiling as soon as possible, warning that the Treasury would need to take “extraordinary measures” to prevent a default if Congress did not act by August 2.

Yellen said the issuance of state and local government series debt (SLGS) will be suspended at 24:00 GMT on July 30 until the debt ceiling is suspended or raised.

In a letter to House Speaker Nancy Pelosi, Yellen said Oct. 1, the first day of the next fiscal year, could be a critical date for the nation’s ability to pay its debts without new debt ceiling legislation, because of the large amount of federal spending.

Legendary economist David Rosenberg reported last week that the US debt ceiling could have an impact on markets:

“Watch this deal [to raise the debt ceiling] closely — it hasn’t seeped into the market’s thinking yet.”

We asked five analysts, economists and fixed-income investors how the expiration of the U.S. debt ceiling might affect the market.

Can a deal be reached to raise or suspend the debt ceiling by the end of the month?

In fact, none of the five experts expects any deal to raise the U.S. debt ceiling before the end of July.

Nancy Vanden Houten, chief economist at Oxford Economics, said that because the debt ceiling is considered a “must pass” issue, both parties often use it as leverage for other legislation.

The most likely scenario, Houten said, is that the debt ceiling will be raised, but probably as part of a budget reconciliation measure that Congress isn’t expected to pass until the fall.

Joseph Abate, strategist at Barclays, said:

“The likelihood of resuspending the debt ceiling before July 31 is low. “I think a lot depends on the congressional negotiations on the infrastructure bill and whether they can get a bipartisan bill through the House and get enough votes in the Senate.”

When will the Treasury run out of unconventional measures?

The Treasury has taken extraordinary measures in the past, such as suspending different programs, and Congress has always raised the debt ceiling before those measures run out. Jeff Hibbeler, fixed income portfolio manager at Exencial Wealth Advisors, said:

“Several analysts [reports] I’ve read suggest that October could be the date [for a deal to raise the debt ceiling]. But it depends on the legislative process and how much they want to tie it to the various budgets or other legislation they’re trying to pass.”

All five experts agreed that the Treasury should be able to take unconventional measures by the fall:

“We think they probably have enough cash and borrowing authority to get through September and October.”

Why warn now?

Experts say it is not uncommon for a U.S. Treasury secretary to issue a warning to lawmakers, if for nothing else, generally to prompt them to act quickly. Exencial’s Hibele says:

“The Treasury secretaries don’t want there to be any doubt [about] whether the United States is going to honor its obligations.”

Vanden Houten of the University of Oxford says this is a more unusual time, given the huge costs associated with the outbreak. Vanden Houten says:

“While Congress has always managed to raise or extend the debt ceiling in a timely manner, there is no guarantee that it will do so again, but the consequences of not doing so would be severe.”

How will the market react?

Even if the July deadline passes, market reaction is expected to be muted, experts said. Overall market volatility is likely to rise only if the Treasury’s unconventional measures are exhausted, with the biggest impact on short-term Treasury bills. Overall, however, big, wild swings in yields are unlikely.

Dan Krieter, head of fixed income strategy at BMO Capital Markets, said some short-term investors may view the maturity date as a good opportunity to buy Treasurys at lower costs.

Barclays’ Abate said Treasury yields are likely to fall when investors know extraordinary measures could be exhausted.

Vanden Houten of The University of Oxford also expects more volatility in financial markets, especially if there is still uncertainty about when Congress will raise the cap. Vanden Houten said:

“If the risk of a recession rises, stock prices could fall, and bond investors could demand higher yields if they think there is an increased risk that the Treasury will not be able to repay its debt.”

David Roberts, co-head of Liontrust’s global fixed income portfolio, said that even if the cap was raised at the last minute, it would not have a significant long-term impact on the market.

The last time that happened was in 2011, when the ratings agency Standard & Poor’s downgraded U.S. Debt, and the United States lost its AAA debt rating. However, US Treasury bonds remain among the highest rated in the world, suggesting that markets have little doubt about us creditworthiness.