Key Takeaways 

  • We think Congress will reach a deal on the debt ceiling

    that avoids technical default, but building market stress

    (weaker equities/USD and widening credit spreads)

    could be part of the incentive to get the job done.

  • An eventual agreement is likely to deliver cuts to

    government spending. While Democrats are

    attempting to minimise these, some tightening in fiscal

    policy supports our call for a recession later this year.

  • A short breach of the x-date would trigger very sharp

    market reactions, even if the Treasury prioritises

    payments to bond holders. Drops in equities of

    perhaps 10%, severe stress in other risk assets, dollar

    depreciation and a looming downturn would likely push

    Congress to raise the ceiling rapidly.

  • In the very unlikely scenario in which Congress does

    not act for weeks or even months following a technical

    default, we expect very large shocks to economic

    activity and much deeper adjustments in markets.

  • President Biden could bypass Congress and avoid a

    default, by using the 14th Amendment or minting a $1tn

    coin. But these actions come with significant costs and

    are only likely in the case of extreme stress.

     

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