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Here’s what could happen in markets if the US defaults: NPR




Here’s what could happen in markets if the US defaults: NPR

A US debt default will lead to a fall in stock and bond markets, while eroding America’s financial position in the world, analysts say.

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A US debt default will lead to a fall in stock and bond markets, while eroding America’s financial position in the world, analysts say.

Michael M. Santiago/Getty Images

The deadlines! The arm twist! The threat of default!

The U.S. may be just days away from being unable to pay its bills, but Wall Street has seen this movie before, and markets seem unaffected — for now.

“One staffer on Capitol Hill likened this, the debt ceiling, to passing a kidney stone,” says Libby Cantrill, head of public policy at PIMCO, which manages some of the world’s largest bond funds. “We all know it will pass. It’s just a matter of how painful it will be.”

On Wall Street, everyone recognizes that a debt default would be devastating to markets and the economy, and most investors believe that lawmakers will eventually make a deal as they have done in the past.

“We think the stakes are too high for both sides of the aisle to really not come together,” said Eric Freedman, chief investment officer at US Bank Asset Management Group.

Nonetheless, portfolio managers are still figuring out what might happen if lawmakers fail to strike a deal to raise or suspend the debt ceiling.

If that were to be the case, the impact would be severe. Here’s what you can expect.

How bad would it be?

At the very least, there would be a big sell-off on Wall Street. In its latest analysis, UBS says the S&P 500 could fall by at least 20%.

But it is hard to predict how bad things could get because the US has never defaulted on its debt.

Analysts believe the sell-off could match or surpass a steep fall in September 2008, when the House of Representatives rejected a $700 billion bailout as the United States was on the brink of the global financial crisis.

Then-President George W. Bush stands with Federal Reserve Chairman Ben Bernanke (L), Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox to discuss the economy at the White House in Washington, DC, September 19, 2008.

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Then-President George W. Bush stands with Federal Reserve Chairman Ben Bernanke (L), Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox to discuss the economy at the White House in Washington, DC, September 19, 2008.

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The Dow Jones Industrial Average fell about 778 points that day, which was the biggest one-day drop in the index’s history.

A default would also send the US bond markets sharply lower.

Treasurys have been regarded as some of the safest investments worldwide. They are held by companies and countries around the world and used as collateral in all types of financial transactions. If the federal government failed to pay the bondholders, it would have unimaginable consequences for the position of the United States.

A default would also weaken the US dollar, which is widely regarded as the world’s most important currency given the critical role it plays in the global economy.

“The world’s most important reserve currency and the world’s ‘safe’ asset, which forms the bedrock of the global financial system, is suddenly much less safe and should be repriced,” UBS economists wrote in a May 19 note to clients. “How it goes through the system is unpredictable.”

Analysts also believe that credit rating agencies will downgrade the country’s credit rating.

Currently, the US has an “AAA” rating from two of the three major credit agencies. The US received a downgrade in 2011 from the other major rating agency, when S&P Global Ratings lowered the country’s rating to AA+ amid a new round of debt negotiations under President Obama.

How would the market turmoil affect me?

Most obviously, a sharp drop in shares will hit retirement or other investment funds across the board. At the same time, the bond markets determine all types of borrowing costs, which would be significantly higher if there was a default in the US.

This would be more bad news for anyone hoping to buy a house or a car at a time when borrowing costs have already risen after the Federal Reserve raised interest rates aggressively to combat high inflation. Mortgage rates, for example, would rise even higher, as would credit card rates.

Federal Reserve Chairman Jerome Powell arrives to testify before the Senate Banking Committee on Capitol Hill in Washington, DC, March 7, 2023.

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Federal Reserve Chairman Jerome Powell arrives to testify before the Senate Banking Committee on Capitol Hill in Washington, DC, March 7, 2023.

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Inflation has cooled somewhat, but it is still nowhere near the Fed’s 2% target, and many economists expect the US to be headed for a recession. On top of that, there is still turmoil in the banking sector following the recent failures of three regional lenders.

“There is already significant pressure on the US economy,” says Seema Shah, senior global investment strategist at Principal Global Investments. “It cannot afford another big shock to its head.”

Shah echoes what policymakers have said, that a sovereign default would not only start a domestic recession, but also potentially another global financial crisis.

Is that how it’s going to be?

As long as the US has this limit on how much they can borrow, it seems likely.

Lawmakers have voted to raise the debt ceiling more than 100 times, but debates over the debt limit have become increasingly fractious and used as a political weapon.

In recent days, company managers have become more involved in the process.

On Thursday, Treasury Secretary Janet Yellen met with dozens of bank chiefs, while more than 100 executives wrote a letter to President Biden and congressional leaders, warning them of the consequences of inaction and encouraging them to raise the debt limit.

“Action to end the pending debt crisis is needed now,” they wrote, noting that a default “would weaken our position in the world financial system.”

“We strongly urge that an agreement be reached quickly so that the country can avert this potentially devastating scenario.



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