Practical analysis for investment professionals
17 January 2013

Poll: How Will Financial Markets React If the United States Defaults on Its Debt?

Posted In: Economics

In a poll conducted earlier this week in the CFA Institute Financial NewsBrief, we asked readers how they expected financial markets to react if the United States fails to resolve its debt-ceiling crisis and subsequently defaults on its debt.

Poll: If the US fails to resolve its debt-ceiling crisis and defaults on its debt, how do you expect world financial markets will react?

Poll: If the US fails to resolve its debt-ceiling crisis and defaults on its debt, how do you expect world financial markets will react?

Just over 60% of respondents to this week’s poll expect that if the US government fails to resolve its debt-ceiling crisis and defaults on its debt, any negative market impact would be short-lived. Approximately 22% of respondents think the consequences of default would be more long-lasting, with long-term borrowing rates rising and the United States losing its reserve currency status. Only 18% of respondents view the debt-ceiling crisis as largely a political dispute that is likely to be ignored by markets.

The US government will hit the statutory limit on its ability to borrow sometime between mid-February and early March, and unless Congress authorizes an increase in the debt ceiling, the government will not be able to meet all of its financial obligations. There is currently a standoff in Washington, with the Republicans tying any increase in the debt limit to future spending cuts, a precondition opposed by President Obama and the Democrats.

There is also disagreement over what exactly constitutes a default. Without a debt limit increase, the government would be able to pay about 60% of its bills. Republicans have suggested that by prioritizing payments the government can pay the interest on its debt and thus avoid technical default, an approach that has been dismissed by President Obama and the Democrats as legally tenuous and logistically impossible.

While the political squabbling has garnered most of the headlines, there are real financial consequences at stake. Fitch Ratings has indicated that the proposed prioritization plan would “very likely” result in a downgrade of the country’s credit rating. Fitch has also warned that any deal should include meaningful steps toward deficit reduction. Certain to follow any downgrade would be increased borrowing costs, which would have a negative ripple effect on the global economy.

If this crisis sounds familiar, it is because we went through it before. The debt-ceiling wrangling of July 2011 led to a downgrade of US debt and a 15% sell-off for US stocks. And while stocks did recover in 2011 and the country’s reserve currency status was never in jeopardy, it is clear that without meaningful long-term fiscal reforms, markets in the future may not be so forgiving.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
David Larrabee, CFA

David Larrabee, CFA, was director of member and corporate products at CFA Institute and served as the subject matter expert in portfolio management and equity investments. Previously, he spent two decades in the asset management industry as a portfolio manager and analyst. He holds a BA in economics from Colgate University and an MBA in finance from Fordham University. Topical Expertise: Equity Investments · Portfolio Management

3 thoughts on “Poll: How Will Financial Markets React If the United States Defaults on Its Debt?”

  1. The ripple effect of the Congress not able to resolve the debt–ceiling crisis will surely, have a short term duration on the World financial market; and it will definitely, lead to United States losing it’s credit rating again. Soundingly alarmy, at the long run will lead to U.S not able to borrow money at a good rate for a long time until their credit rating is upgraded for fair rate interest payment. On the stock market overall, it will surely have a short-lived effect on the stock market.

  2. David says:

    There is no way congress would let that happen to our credit rating and financial system. This is just one big game of chicken by politicians (I hope).

  3. I think majority of the answers (~60%) take a psychological comfort from the ‘fact’ that US will never default and that is what reflects in the idea that the markets will rebound post a default. Rationally speaking, a default leaves little difference between the treasuries and high yield bonds, and the returns are simply not comparable. I don’t think investors would respond in a similar manner if the default was expected from a company instead of the government. The expected recovery has more to do with the concealed belief that the default won’t take place. I think the US will neither default, nor can the markets rebound after a default.

    Jimmy Dotiwala, CFA

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