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Market Update - The US debt ceiling impasse and potential implications for the US financial markets

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Market Update - The US debt ceiling impasse and potential implications for the US financial markets

May 10, 2023

  • The United States reached its debt ceiling of USD31.4 trillion in January 2023, leading the Department of the Treasury to initiate “extraordinary measures” to continue to fund government spending. Unless the debt ceiling is raised, the US can not issue any more debt, which will result in it defaulting on its obligations. This could have grave consequences for the US and global economy and financial markets
  • Currently, there are ongoing discussions within the US Government to ensure a default will not happen. To quote Senate Republican leader Mitch McConnell “I’ve seen this movie several times over the years … I think the important thing to say is there will be no default, will not happen, ever, won’t happen this time.”
  • The current US banking turmoil could be made worse by the debt ceiling situation. The FDIC and Treasury can’t guarantee deposits and stop outflows because they are running low on cash and can’t issue new debt until the ceiling is raised
  • The extent to which the Treasury will be able to fund the government’s ongoing operations using current cash balances remains uncertain. Given the slower economic growth this year, Government receipts remain weak, and the Treasury could run out of funds anywhere from 1st June – 30th August 2023
  • There are three possible outcomes. First, a deal is made, and the debt ceiling is raised. This would be positive for both fixed income and equity markets since the US markets would once again trade on fundamentals
  • Second, a bill is passed to suspend the debt ceiling to give lawmakers and the White House more time to reach a deal. This would keep uncertainty and volatility high in both fixed income and equity markets in the US
  • Third, and the least likely scenario, is where no agreement is reached, and the US officially defaults on its debt. This would alter the perception of the risk-free rate, US Treasury and credit markets would clearly trade differently, but as the largest and most liquid market in the world, it could provide safety for investors. Corporate credit markets could benefit as fixed income investors seek healthy balance sheets. Like in 2011, the risk-off sentiment would cause equities to sell off materially for a short period

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