Wall Street warns of the most serious confrontation of the US debt limit since 2011

Wall Street banks, including JPMorgan and Goldman Sachs, are warning that Washington is heading toward the riskiest debt ceiling encounter since 2011, when the US lost its risk-free credit rating.

The struggle over the debt ceiling could be the most important issue facing American economy in 2023, according to a JPMorgan note to clients on Friday.

Congress has fought a lot over raising the borrowing limit in recent years and has not defaulted on its debt. Given the particularly volatile state of the legislature, it may be difficult to complete a deal to prevent the world’s largest economy from defaulting on its debt this time, said Michael Feroli, chief US economist at JPMorgan.

Ferulli added that the repercussions of a default were hard to predict, but could reasonably lead to a “severe recession”.

“Even the best-case scenario will likely see the kind of brinkmanship that occurred in the 2011 debt-ceiling crisis,” he said.

The US Treasury market is the bedrock of the global financial system and a haven for central banks and investors globally. Debt defaults are likely to have cascading effects across multiple asset classes and geographies.

Last week, the government began taking “extraordinary measures” to fulfill its obligations after the country It reached the borrowing limit of $31.4 trillion. The Republican majority in the House of Representatives demanded deep budget cuts in return for raising the debt ceiling. The White House and the Democratic majority in the Senate say that’s not an option.

In recent decades, the debt ceiling has regularly devolved into a partisan battle in Washington when government has been divided. But some critics believe the looming showdown will be particularly difficult to resolve because the House speaker is a Republican Kevin McCarthy Securing the election in part by promising to play ball with the Democrats.

McCarthy was elected after 15 rounds of voting after a hawkish minority refused to support his presidency, suggesting a fractured Republican caucus may be unwilling to vote on a deal even if a compromise is reached.

“We have the most risk of debt limit problems since 2011,” said Alec Phillips, chief political economist at Goldman Sachs, adding that US debt is larger this time and higher. interest rates.

“This is a slightly different episode from the debt ceiling,” said Pablo Villanueva, chief US economist at UBS, because the Fed is engaged in quantitative tightening and withdrawing cash “very quickly” from the economy after years of monetary stimulus.

“That’s why I think the debt ceiling is particularly important this time around,” he added.

For now, US government and corporate bonds started the year on an optimistic note, buoyed by signs of declining inflation and hopes that the Federal Reserve will moderate its stated intent to continue raising interest rates.

However, some market participants warn that investors are not pricing in the high-stakes standoff, as many expect Congress will capitulate.

“In the past, Congress acted before date ‘X,’” Villanueva said. “So I think the market is setting a very high probability that Congress will act again.”

“The debt ceiling is not affecting our market right now. But I would expect any effects to be visible in the second half,” said Megan Graber, Global Joint Head of Investment Grade Syndicate at Barclays.

“This year’s debt ceiling is a little different than some of the debt ceiling dramas we’ve dealt with in the past couple of years,” said Maureen O’Connor, global president of quality debt syndicate at Wells Fargo.

She added, “When we talk about Black Swan events, this is one of those events.”