How Wall Street Is Preparing for a Debt Ceiling Showdown

If the federal government were to default on its debt, the consequences would be devastating, undermining the United States’ role at the center of global finance and threatening to plunge the economy into recession. But the stock market shows no signs of panic after the government hits the debt ceiling and the day nears when it runs out of cash to pay the bills, with the S&P 500 up more than 7% for the year. .

Because, simply put, equity investors are faced with an alternative. As in the past, either legislators will raise the state’s borrowing limit at the last minute, or the state will fail to meet its obligations, with potentially catastrophic consequences difficult for investors. Even if you understand it, it will not be reflected in the stock price.

The exact date when the government’s cash will run out, known as the X-date, is unknown, which also complicates investors’ trading decisions. Recent comments from Treasury Secretary Janet L. Yellen suggest as early as June 1.

“What you’re looking at is the consensus view that it won’t cross the X-date,” said Bank of America rates strategist Ralph Axel. stay.”

But if the government runs out of money and other workarounds fail, the impact of a debt default will hurt an economy already on the “doorstep of recession,” said the Wells Fargo Investment Institute. said Paul Christopher, Head of Global Investment Strategy at .

“There remains the question of default or not,” said Christopher. “They’ve worked this out every time in the past, so that’s the best bet, but it can be a very unpleasant surprise if you’re not careful.”

President Biden is scheduled to meet with House Speaker Kevin McCarthy on Thursday to discuss the debt ceiling, with Republicans in the House pushing for significant spending cuts as a condition of raising the debt ceiling. Mr. Biden has refused to link his spending decisions to raising the debt ceiling.

The closest to the current stalemate was the brink of exceeding the August 2011 debt ceiling. In July, the S&P 500 traded near its highs for the year. But by the time the S&P downgraded the country’s credit rating on his Friday, Aug. 5, the index had fallen more than 10% of his. By next Monday, the index had fallen more than 16% from his July peak.

Investors are aware of the risk of a recurrence, and outside the stock market, signs of caution are creeping in. Investors are already holding back on government debt that will mature around the time the government is expected to run out of money.

Last week, the Treasury Department borrowed money at an interest rate of about 6% for four weeks. This far outstrips recent longer term borrowings, reflecting investor anxiety over what happens before and after the X date.

The cost of protecting governments from not paying their debts using derivative contracts called credit default swaps has also skyrocketed, suggesting an increased likelihood of default.

Gold prices have increased by more than 10% over the past two months. This is partly due to investors seeking safety in precious metals, and market turmoil is expected to sustain their value. With many investors already positioning their portfolios defensively, it’s hard to disentangle some of this trading activity from broader concerns about the economy, especially after a string of recent banking troubles.

Yet even stock investors have begun to hedge their bets by buying derivatives that pay out if the stock market suddenly drops in the coming months.

Stuart Kaiser, an equity analyst at Citigroup, said he also answered questions from investors about which parts of the stock market are most dependent on government funding, such as health care and defense stocks. companies could be left with unpaid bills in the event of default or face future funding cuts as part of a negotiated deal in Washington.

“People are dusting off their 2011 playbooks and sharpening their pencils for 2023,” he said.

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