- The White House has cautioned that a potential US default on its debt may result in a 45% crash in the stock market.
- As the US Treasury utilizes its extraordinary measures, the approaching debt ceiling deadline in early June draws near.
- Today, President Joe Biden and House Speaker Kevin McCarthy have a scheduled meeting to discuss the debt ceiling.
Earlier this month, the Council of Economic Advisers at the White House cautioned that a US debt default could trigger a severe economic downturn comparable to the Great Financial Crisis of 2008, along with a staggering 45% stock market crash.
With the approaching deadline in early June, Treasury Secretary Janet Yellen is depleting all extraordinary measures available as lawmakers face the task of raising the debt limit. Failing to reach an agreement on the debt ceiling could result in the Treasury being unable to make Social Security payments, payments to Medicare and Medicaid, and eventually, payments to US bond holders.
The possibility of a debt default in mid-June has caused a significant increase in the US 1-month Treasury yield, rising from its previous low of 3.31% last month to 5.56%.
On May 3, the White House Council of Economic Advisers expressed that as the United States approaches the debt ceiling, they anticipate a deterioration in market-stress indicators. This is likely to result in heightened volatility in the equity and corporate bond markets, impeding firms from securing necessary financing and engaging in productive investments crucial for sustaining the ongoing economic expansion.
However, alternative market indicators suggest a low probability of a US debt default occurring. The VIX fear gauge, a measure of market sentiment, is trading at low levels, and the overall stock market is near its highest point in the past year. Additionally, credit default swaps currently indicate a mere 4% likelihood of a US debt default, as reported by JPMorgan.
In the event of an extended US debt default, characterized by a failure to promptly resolve the default, the White House cautioned that the stock market could experience a sharp decline of 45%. This would potentially result in the S&P 500 index reaching a level of 2,250, based on its trading position as of May 3.
Furthermore, according to the Council of Economic Advisers (CEA), a protracted US debt default would have severe consequences, including a significant loss of employment for millions of individuals and a sharp economic downturn resulting in a substantial recession.
These projections are based on a simulation conducted by the White House, which aimed to assess potential outcomes if the US were to default on its debt for the first time in its 246-year history.
The CEA stated that in the third quarter of 2023, which represents the initial full quarter following the simulated breach of the debt ceiling, the stock market would plummet by 45%. This would have a detrimental impact on retirement accounts. Additionally, both consumer and business confidence would suffer substantial blows, leading to reduced consumption and investment activities. Furthermore, the CEA emphasized that unemployment would rise by 5 percentage points.
Adding to the gravity of the situation, in the event of a prolonged default, the government would be incapacitated in implementing fiscal stimulus measures to bolster the economy, similar to the actions taken during the COVID-19 pandemic and in the aftermath of the 2008 Great Financial Crisis.
The Council of Economic Advisers (CEA) drew comparisons between its findings and a simulation conducted by credit rating agency Moody’s, which suggests that an extended default scenario could result in the loss of nearly 8 million jobs.
The CEA explained that the absence of the capacity to allocate funds toward counter-cyclical measures, such as extended unemployment insurance, would hinder the ability of federal and state governments to respond to the ensuing turmoil and shield households from its impacts.
Moreover, the CEA warned that US households would be unable to rely on the private sector for loans due to a significant surge in interest rates for credit cards and personal loans.
It is worth noting that President Joe Biden and House Speaker Kevin McCarthy have a scheduled meeting today to discuss the matter of the debt ceiling.