Author: Simon Moore, April14, 2023 https://www.forbes.com/sites/simonmoore/2023/04/14/debt-limit-risks-escalate-as-2023-deadline-nears/?sh=2f34ab80cb57

With no resolution on the U.S. debt limit, the cost of insuring Treasuries against default continues to edge up steadily. The U.S. hit its debt ceiling in January, and the Treasury is currently using extraordinary measures to pay the bills, essentially borrowing from long-term government funds to make operational payments. That’s not sustainable and funds would be exhausted by the summer or early fall on current estimates from the Bipartisan Policy Center.

Market Assessment

The market’s view on the risks from the debt ceiling can be measured via credit default swaps. These are essentially a measure of the risks associated with U.S. government debt.

In the worst case, lack of progress on the debt ceiling could cause the U.S. to default on debt payments. Credit default swaps have risen since summer 2022, implying rising risk to U.S. government debt. However, the risks remain relatively small in absolute terms with the chance of default still estimated at well under 1%. That said, the costs of default would be extremely high, and any questioning of the robustness of the U.S. debt markets is potentially damaging. For example, in 2011 the U.S. avoided default, but the repercussions for financial markets were severe as the U.S. credit rating was downgraded and equity markets fell.

Political Progress

A deal between President Biden and House Speaker Kevin McCarthy is needed to raise the debt ceiling. On March 28, McCarthy stated there had been “no progress”, with no meeting with Biden since February 1. In the 15-vote process to elect McCarthy as speaker, he apparently agreed to not raise the debt ceiling without associated spending cuts. In contrast, the President is looking to raise the debt ceiling via a “clean” standalone measure. Hence, for now, talks are at an impasse. In recent weeks Republicans have suggested moving their own bill.

Market Implications

The debt limit issue is likely to be resolved. Historically, deals on raising the debt limit have always been found. Nonetheless, the risks for financial markets are extreme. The debt limit was formally exceeded almost three months ago, even if “extraordinary measures” have kept the government functioning since then. It is also notable that today’s debt ceiling debate has parallels to 2011. Then a Democrat President was dealing with a newly Republican-led House after midterm elections. Exactly the setup we have today.