With the US debt ceiling hit, the Treasury is looking for ways to save cash. After strategies run out, what once seemed unfathomable can become a reality. In other words, the default of the US debt.
what happens next?
From shockwaves in financial markets to bankruptcies, recessions, and irreparable damage to the nation’s long-standing role as the center of the global economy, the full range of impacts are difficult to fully predict.
A default remains unlikely, at least given the promises of opposition lawmakers that there will be a deal to raise or end the debt ceiling and the long-term odds implied by trading in certain financial markets. But as the day nears when the United States will begin to run short of the cash needed to pay its bills, which could be as early as June 1, investors, business owners and economists around the world are warning that just before Predict what will happen during and immediately after. They have contingency plans and are baffled by poorly tested rules and procedures.
“We are embarking on uncharted waters,” said Andy Sparks, head of portfolio management and research at MSCI, which produces indices that track a wide range of financial assets, including the Treasury market.
On the verge of default, a “horror scenario” comes into view.
Some financial markets are already shaking, but the ripples pale in comparison to the tidal wave that rises as default approaches. The $24 trillion U.S. Treasury market is the government’s primary source of funding and is also the world’s largest bond market.
The government bond market is the backbone of the financial system and vital to everything from mortgage rates to the dollar, the world’s most widely used currency. Because the government’s creditworthiness is guaranteed, Treasury debt is sometimes treated the same as cash.
A shattering of such deeply ingrained market trust would have consequences that are difficult to quantify. But Calvin Norris, portfolio manager and rates strategist at Aegon Asset Management, said most agreed that a default would be “catastrophic.” “It’s going to be a horror scenario.”
Delayed payments set off a trading frenzy as markets begin to fray.
The government pays its debts through banks that are members of the federal payment system called Fedwire. These payments flow through the market plumbing and eventually reach the accounts of debtors such as individual savers, pension funds, insurance companies and central banks.
If the Treasury wants to change the repayment date to an investor, it must notify Fedwire the day before the payment is due, so the investor is on the eve of the government’s default on its debt. you will know.
Analysts at TD Securities have more than $1 trillion in Treasury debt maturing between May 31 and the end of June that could be refinanced to avoid a default. It also has an interest payment term of $13.6 billion, payable over 11 periods. That means there are 11 opportunities for the government to default on payments over the next month.
Fedwire, our payment system, closes at 4:30pm. If payment is not made by this time, the market will start to turmoil at the latest.
Stocks, corporate bonds and the dollar will probably crash. Volatility could be extremely high, not just in the US, but around the world. In 2011, the S&P 500 fell 17% in just over two weeks as lawmakers struck a last-minute deal to avoid debt-limit violations. Post-default reactions could be even harsher.
Perhaps counterintuitively, demand for some government bonds will increase. Investors are likely to sell all of their maturing Treasuries (for example, some money market funds have already shifted their holdings from U.S. Treasuries maturing in June), and even more We will buy other government bonds ahead, but still think that the payment deadline is still ahead. A refuge during stressful times.
A spate of downgrades drives “madness” among bondholders.
Joydeep Mukerji, a leading U.S. credit ratings analyst at S&P Global Ratings, said the government would be considered in a “selective default” if it failed to pay. This means that the government has chosen to refuse some payments, but is expected to continue payments. Paying off other debts.Fitch rating also said Similarly, government ratings will be downgraded. Such ratings are usually assigned to corporate or government borrowers in crisis.
Another major rating agency, Moody’s, said that if the Treasury missed even one interest payment, it would cut its credit rating by one notch to just below its current highest rating. Failure to make a second interest payment will result in a further downgrade.
Moody’s said a number of government-affiliated issuers, ranging from government agencies that underpin the mortgage market to government-funded hospitals, government contractors, railroads, power companies and defense companies, are also likely to face downgrades. pointed out. It would also include foreign governments that have their debt guaranteed by the United States, such as Israel.
Some fund managers are particularly sensitive to downgrades, which could drive prices down as they are forced to sell their holdings of U.S. Treasuries to meet rules about the minimum ratings they are allowed to hold.
“Besides the first degree of insanity, I fear there will be a second degree of insanity. For example, if two of the three major rating agencies downgrade something, there will be a large number of financial institutions unable to maintain that rating. There will be, Chicago Fed President Austan Goolsby said Tuesday night at an event in Florida.
The plumbing of the financial system freezes, transaction costs rise and become difficult.
Importantly, according to the Securities Industry and Financial Markets Association, an industry group, the default of one government note, bank note or bond does not trigger the default of an entire set of government debt, known as a “cross-default.” This means that much of the government debt will remain as it is.
That should limit the impact on markets that rely on Treasury debt as collateral, including trillions of dollars worth of derivative contracts and short-term loans called repo contracts.
Nonetheless, collateral affected by default must be replaced. Leading derivatives clearing firm CME Group may ban short-term Treasury bills from being used as collateral or apply discounts to the value of some assets used to secure transactions, although it has no plans to do so. said there is.
There is a risk that the pipes of the financial system will simply freeze as it becomes more difficult to buy or sell any asset as the big banks facilitating the deal pull out of the market while investors rush to reposition their portfolios.
A few investors could make big gains amid this turmoil in the days following the default. After the three-day grace period expires, about $12 billion in credit default swaps, a form of bond default protection, could be triggered. Payment decisions are industrial committee This includes large banks and fund managers.
The country’s global financial reputation is permanently tarnished.
As the panic subsides, confidence in the country’s fundamental role in the global economy could change forever.
Foreign investors and the government hold $7.6 trillion, or 31% of all Treasury bonds, essential to the favorable funding environment the U.S. government has enjoyed for years.
After a default, however, the risk of holding Treasury debt could increase, and the government’s borrowing costs could be higher in the near term. The central role of the dollar in global trade could also be undermined.
Higher government borrowing costs will also make it more expensive for companies to issue corporate bonds and take out loans, and higher interest rates for consumers to take out mortgages and take out credit cards.
Economically, White House predictions Even a short-term default would result in the loss of half a million jobs and a rather shallow recession. If the default persists, those figures would devastatingly destroy 8 million jobs and plunge the economy into a deep recession, shrinking by more than 6 percent.
Although the total amount of these potential costs is unknown, they are widely believed to be enormous, and many believe this will motivate lawmakers to reach an agreement on the debt limit. “All the leaders out there understand the consequences if we don’t pay our bills,” Biden said in a speech Wednesday as negotiations between Democrats and Republicans heat up. “This country has never defaulted and will never default,” he added.
