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.