Interview
What happens if the U.S. government can’t pay its bills?
- A failure to raise the debt limit before the deadline is expected to cause substantial equity volatility, with the current political environment posing a risk comparable to or exceeding the disruptions seen in 2011 and 2013.
- The Treasury forecasts a potential cash exhaustion by early June, with Secretary Yellen setting this as a cutoff despite non-withheld tax receipts being lower than expected and California residents having a later tax deadline.
- If the cash runway extends two weeks past the deadline, a default is considered almost certain, potentially triggering a cycle where payments are delayed until sufficient cash accumulates for a full day's worth of transactions.
- While debt service payments like coupon redemptions are likely to be prioritized by the Treasury and Fed, a delay lasting more than a few days could pull significant capital out of the economy and tip the fragile economy into recession.
- A direct economic hit from stopping payments is estimated at approximately $10 billion per day, with indirect effects on financial markets and consumer confidence potentially causing more severe damage than the initial fiscal shortfall.
- Republicans have proposed a $4.8 trillion deficit reduction plan over 10 years involving spending cuts back to 2023 levels, while the House-passed bill represents a $3.2 trillion reduction, though the most likely outcome is a less restrictive deal.
- Negotiations are scheduled to commence on May 9th between congressional leaders and President Biden, with odds increasing for a short-term extension from early June to late July or the end of the fiscal year.
- Market indicators show Treasury bills maturing near deadlines are trading at higher yields and sovereign credit default swaps are pricing in elevated default risk, while equity volatility is identified as a primary hedge.
- Congressional Republicans face difficulties securing a deal due to a slim majority of nine seats, compared to 63 seats in 2010, making Speaker McCarthy's position more fragile than previous iterations.
- Financial markets may react negatively to a deal reached one day before or even one day after the deadline, as the political incentive for Republicans to extend negotiations beyond the point where Social Security checks are questioned is low.
- While the base case does not assume a late July cash exhaustion, projections suggest a credible chance of running out of funds in June, contingent on tax receipts replenishing cash after the June 15th deadline.
- The political climate regarding debt limit votes is anticipated to be less unfavorable than in 2011, yet internal guidelines from previous episodes suggest uncertainty regarding the ability to maintain all debt service payments under stress.