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Markets will breathe a sigh of relief if lawmakers can reach agreement on the debt ceiling to prevent a default. But markets can’t always get what they want.
The stock market largely ignored the serious risks associated with a US default. But as the Treasury Department’s estimated default date of June 1 approaches, the exchange is poised to take note.
Even if an agreement is reached, it could take months for stocks and other financial markets to move forward.
“One of my concerns is that even before an agreement is reached, if it does happen, there could be significant difficulties in financial markets,” Treasury Secretary Janet Yellen said on Wednesday.
“We are just at the beginning,” she said, referring to the volatility in the stock and bond markets over the past few days.
Alex Brandon/AP
House Speaker Kevin McCarthy of California speaks during his meeting with President Joe Biden to discuss the debt limit in the Oval Office of the White House Monday, May 22, 2023 in Washington. (AP Photo/Alex Brandon)
If markets ultimately get what they want — no debt default — they will have to brace themselves for a potentially rough ride immediately after a deal is signed.
This is because the Treasury Department needs to immediately replenish the cash it used up during the period of extraordinary measures, when it was unable to borrow any more money.
This will lead to more competition for equity from investors, said Michael Reynolds, vice president of investment strategy at Glenmede. After considering their options, many investors may find that investing in US Treasuries offers better returns than stocks. That will temporarily remove some liquidity from the stock market, he said.
In 2011, lawmakers agreed to raise the debt ceiling just hours before the US defaulted. Two days later, Standard & Poor’s downgraded US debt for the first time in history.
It took shares two months to recoup losses from the downgrade and initial sell-off before the X-date.
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“It wouldn’t be surprising if the pattern from 2011 were to repeat itself again,” said George Mateyo, chief investment officer at Key Private Bank.
While he doesn’t expect a major credit agency to downgrade the US debt before or after a deal is reached to raise the debt ceiling, the current standoff could result in a major loss of confidence in the US financial system.
That’s why he anticipates months of market volatility even if an agreement is reached.
“Just because we raised the debt ceiling doesn’t mean we’re out of the woods,” Mateyo told CNN.