The showdown over the US debt ceiling in Congress is fast approaching with a possible deadline in early June.
Republicans and Democrats appear to be at an impasse with no progress toward a deal.
These are the four scenarios and their potential impact on the US economy, according to Ned David Research.
The latest debt ceiling showdown appears to be extraordinary because no party fully controls Congress, and it could lead to disastrous results for the US economy, according to a Wednesday note from Ned Davis Research.
While the ongoing U.S. debt ceiling showdown in Congress is nothing new for investors, as the debt ceiling has been raised year after year with a typical spectacle of political theater, it could have serious implications. if the crisis is ultimately not resolved this time around.
“Market participants have been conditioned over the years to expect that any debt ceiling standoff will be resolved in time to avoid a default, even if it is a thread. This rests on confidence that politicians understand that the potential consequences of a default are too severe, including wreaking havoc on the global financial system and causing a recession in the United States and possibly the global economy,” said explained NDR.
The note referred to what happened in 2011 as a barometer of what is possible this time around, in which the S&P 500 fell almost 20% over a period of a few months because the United States lost their AAA rating from Standard and Poor’s due to the tightrope policy that was triggered by a debt ceiling crisis.
“While we expect the debt limit to be adjusted again, we see significant risk of financial market volatility by the X date of June 1,” NDR said.
Those are the four potential outcomes of the current U.S. debt ceiling showdown in Congress, according to the memo.
1. Impasse continues beyond date X – 5% odds.
In this most disastrous scenario, the US government would partially default on its debt due to tightrope politics between Democrats and Republicans. The government would miss payments to retirees, veterans, military personnel and contractors, but it would continue to pay out bonds.
Due to a partial default, US debt would be downgraded by credit rating agencies, leading investors to demand a higher risk premium. There would be a drop in consumer confidence and spending, and the US economy would fall into recession. This is the worst possible scenario for the stock market.
2. Own debt ceiling increase – 10% rating.
In this scenario, a debt default would be averted altogether thanks to the Republicans dropping their demands for last-minute spending cuts. In this scenario, there would be no change in the outlook for economic growth in 2023.
3. Biden gives in to some Republican demands – 20% chance.
In this scenario, a US debt default would be avoided as Biden gives in to some Republican demands for spending cuts. Government spending cuts would go into effect for 2023 and 2024. This would lead to growing uncertainty among investors and businesses, as spending approved by one Congress could be reversed by the next, especially with the likelihood that the next deadline for the debt ceiling down the road could be exploited by the minority political party. This scenario would lead to slower economic growth in 2023 and 2024.
4. Suspended debt ceiling – 65% rating.
In this scenario, Congress suspends the debt ceiling, allowing time for protracted negotiations. This scenario would avoid a default, although some public spending cuts would be likely. If Congress kicks the road for a few months into the fall of 2023, then the same issues would resurface today and that would add the risk of a possible government shutdown. This scenario would lead to slower economic growth in 2023 and 2024.
“We support the outcome of a temporary suspension of the debt ceiling, either for a brief period or until September, when Congress debates the budget for the next fiscal year. The government has done this on several occasions, including seven times between 2013 and 2019,” says NDR.
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