The US debt ceiling talks completely broke down over the weekend.
The first real US government bond payment default risk falls on June 6th.
Without debt ceiling resolution, the US government could place the global financial system in ‘shock’ as soon as June 6th. If not before.
Both President Biden and Senator McCarthy have since suggested they remain optimistic, following an emergency call, with a new meeting planned for Monday.
The debt ceiling talks are behaving like an out of control elevator!
No one knows which way they will go next. Up or down?
I think we can be reasonably sure of two things. Firstly, both Biden and McCarthy are seeking to maintain they are doing their best to reach an agreement in the eyes of American voters. Secondly, both sides appear surprisingly dismissive this late in the game of the other sides requirements for compromise.
President Biden said he was hopeful of a breakthrough in the Monday meeting and stated clearly that what the Republicans were asking for was completely unacceptable.
Personally, I had reduced by probability of default reading from 25% to 10%, but it is this morning back up again at 25%. With risk to the upside. This is not a good situation at all when there is so little time left.
Without debt ceiling resolution, it is expected that the US government would begin to stutter to operate around the 8th of June, but that voluntary winding down of some services could begin as soon as June 1st.
The probability still favours a resolution, but this is only really a hope because this has been the pattern historically. We should all note however, that the American political scene has never been as desperately polarised with so many axes to grind as it is today.
The current severe state of polarisation of the US political scene could indeed be the undoing of any attempts at a resolution. Both sides appear to be seeing the situation as a litmus test for the upcoming Presidential election. Both sides may feel that to give in significantly would be to lose that Presidential race.
This is why the unthinkable could actually happen.
Debt ceiling talks have never occurred at near 130% debt to GDP. Another motivation for the Republicans to hold the line on their requirement for spending cuts. While President Biden says these requests are completely unacceptable.
This is the real question of the day: Could it be that both sides may in some way privately relish a crisis as a means of destroying their opponents?
The historical precedence of US political polarisation should not be left out of the analysis of whether a resolution can be found?
The ’shock’ to the global financial market system would hopefully be short lived, but it may not. A US default, at this time of war and geo-political tensions could well be the final sign-post to a historic turning point for the US dollar. With unimaginable ramifications across all markets worldwide.
Bond prices would drop sharply on all debt globally and do so instantly. Such is the inter-connected nature of financial markets and the direct international exposures to the US bond market.
Stocks could only fall further as a consequence. In fact, a 10% drop would be possible rather quickly. With a full 20% correction not out of the question over time. Such bearish outcomes could persist to some degree even after a late resolution.
A default would be a major psychological reset among global investors as well as financial.
Markets are already trying to look past this impasse, but are markets correctly pricing the ‘behind closed doors feelings and animosity of legislators on both sides?
Market commentary and analysis from Clifford Bennett, chief economist at ACY Securities
