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?
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.
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