While unlikely to occur, a default on U.S. debt would have serious impacts on global financial markets.
Lawmakers in Washington set government spending and revenue plans every fiscal year, usually producing a shortfall that many of us know as the federal budget deficit. The accumulation of these fiscal deficits is what is called the debt of the U.S. government. The debt ceiling limits the amount of borrowing that can take place to pay for the deficits that have occurred and were approved by Congress in the past. It is not related to future expenditures.
The government’s overall borrowing authority is separate from its yearly revenue and spending authority, although the two often create political tension at the same time. Typically, the debt ceiling is raised without much fanfare, but occasionally it’s used as a negotiating point within larger political debates.
While the Treasury can employ what are called “extraordinary measures” to fund the government as the debt ceiling is reached, thus extending the deadline, at some point, the ability to use these measures would run out.
When is the deadline for raising the debt ceiling?
Treasury Secretary Janet Yellen points to June 1 as the likely date beyond which the government would not be able to meet its debt obligations, but other estimates extend the timeline into late June or early July. The deadline remains fluid, but action on the debt limit is looking necessary sometime in May or June.
What happens if the U.S. defaults on its debt?
Prioritization of debt payments is a potential initial route, but credit rating agencies would probably take those measures as representing a default. If this happens, it would affect the government’s ability to meet its spending obligations, which include Social Security and Medicare in addition to interest payments.
Any missed payments would accrue interest, raising the costs for government functions. Additionally, U.S. debt ratings would likely be downgraded, increasing the cost of borrowing when the debt ceiling would eventually be raised.
Has a U.S. default occurred before?
A default on U.S. debt has never occurred. However, the U.S. debt rating did experience a downgrade by Standard & Poors in August 2011.
How would investors be impacted by a default?
Debt ceiling uncertainty is a negative for equity market participants, and investor confidence would be severely affected by a default. Furthermore, U.S. debt serves as the benchmark for the global bond market. Any disruptions would likely ripple across financial markets in the U.S. and abroad and could lead to a recession, says Chief Economist Eugenio Alemán.
What's the likelihood of default?
Both Alemán and Washington Policy Analyst Ed Mills view the likelihood as extremely low. Congress has several options for action on the debt limit, and it’s likely that the Treasury would activate other creative policies in order to avoid default. There’s historical precedent for them taking action deemed potentially outside of legal authority but necessary in a crisis, Mills explains.
Ultimately, while default is not expected, it’s likely we’ll see continued short-term uncertainty as the deadline approaches.
All expressions of opinion reflect the judgment of Raymond James’ chief economist and Washington policy analysts and are subject to change. There is no assurance the trends mentioned will continue or that the forecasts discussed will be realized. Past performance may not be indicative of future results.
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