Friday, June 2, 2023

How does the US debt ceiling affect the financial markets?

On January 19, the United States could no longer borrow in the markets, as it had reached the limit for public debt issuance. But, as ever, the US Treasury is likely to resort to different accounting “tricks” to continue paying both interest and current spending on the debt of the world’s largest economy. But there is a limit to these treasury strategies which do not have a fixed date yet. Treasury chief Yennet Yellen recently said these exception measures would have margin through early June, but with considerable uncertainty depending on the proceeds from the income campaign.

Republicans and Democrats must reach an agreement to eliminate this debt ceiling — with Congress and the Senate still rife with differing majorities — or set a new level of spending. Otherwise, the US debt default would occur. a fact observed only in 1979 when political settlement came too late. At the moment, the difficulty of predicting the moment at which the Treasury will not be able to continue financing the economy and the expectation, although difficult, that the United States will not meet its payments, generate uncertainty in financial markets.

Ignacio Dolce de Espejo, director of investment solutions at Mutuactiveos, explains the origins of this financing system: The debt ceiling is the maximum amount the US government can cumulatively borrow by issuing bonds. It was created under the Second Liberty Bond AC of 1917. If the US government’s debt level reaches the ceiling, it cannot issue more debt, but can resort to limited “extraordinary measures” to pay Treasury obligations and government spending until the “ceiling” is reached. “” has been raised or suspended again. “A suspension or an extension can be achieved with an agreement between the two chambers. It’s happened 78 times since 1960, so it’s very common,” he says.

But the situation is becoming protracted in the context of strong pressure between the two majority parties. Some Republican senators would have to give in to support a new debt ceiling for the country. But he has already placed conditions on President Joe Biden to force more austerity spending. House Republican leader Kevin McCarthy has presented a plan demanding $4.5 trillion in spending cuts, including rolling back part of investment in renewables and student loan forgiveness, offering only an extension of $1.5 trillion in exchange. Or suspension till 2024. “Pressure is not accidental. On the one hand, it is the starting point for negotiation and on the other, it seeks to limit the government’s ability to act. Among other things, because the low spending will also affect the Republicans in the elections”, explains Dolce de Espejo.

Financial instability

Dennis Shane, director of sovereign and public sector ratings at Scope Ratings, believes that every debt ceiling crisis creates financial market volatility. In addition, these recurring crises have led to phases of debt payment crisis by the federal government and reliance on last-minute actions by Congress to ensure full and timely payments. Furthermore, the 1979 technical default disproved the idea that the debt ceiling problem is always resolved in time.

This is already being reflected in the markets: “The cost of insurance against US sovereign debt default has also reached a multi-decade high: nearly 150 basis points compared to the one-year credit default swap spread of 14 bp (0.14)”. points (1.5 points. points) in early 2023, and above the level of the 2011 debt ceiling crisis”, explains Shen. In fact, this financial ratings firm has kept the US debt rating on negative watch since May, currently at the AA (Double A) level.

George Brown, an economist at Schroders, also sees a risk in the delayed agreement that it could lead to a technical default in the United States. “In 2011, when Congress spent months before raising the debt ceiling on just two days’ notice, investors panicked. Shortly thereafter, the United States lost its AAA rating for the first time. In a recent study, experts point out that risk aversion resulted in the depreciation of the dollar, the collapse of the S&P 500, and the expansion of credit spreads.

Faced with the risk of a repeat of the crisis, investors should consider the state of their portfolios. “Parking principal in Treasuries can be attractive given current yields, but historically these have come under pressure as the clock ticks down on debt ceiling terms. Instead, investors may be tempted to invest in precious metals as well as safe-haven currencies. and should consider an overweight allocation to non-US bonds,” recommends Brown.

Along the same lines, Craig Erlam, OANDA’s senior market analyst for Europe and the Middle East, points out that “the debt ceiling drama could support gold and avoid a deeper correction. I think everyone is pretty convinced that a Default won’t happen, but the closer we get to the deadline, the more we’ll see those risk aversion trading in markets that could support gold,” he concluded.

Nation World News Desk
Nation World News Desk
Nation World News is the fastest emerging news website covering all the latest news, world’s top stories, science news entertainment sports cricket’s latest discoveries, new technology gadgets, politics news, and more.
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