Here's what could happen in markets if the U.S. defaults. Hint: It won't be pretty
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The deadlines! The arm-twisting! 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 seems unbothered — for now.
"One staffer on Capitol Hill likened this, the debt ceiling, to passing a kidney stone," says Libby Cantrill, the 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 question of how painful it will be."
On Wall Street, everybody acknowledges a debt default would be devastating for markets and the economy, and most investors believe lawmakers will eventually clinch a deal as they have in the past.
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"We think the stakes are too high for both sides of the aisle to really not reconcile," says Eric Freedman, chief investment officer at U.S. Bank Asset Management Group.
Nonetheless, portfolio managers are still gaming out what could happen if lawmakers are unable to pass a deal to raise or suspend the debt ceiling.
If that were to be the case, the impact would be severe. Here's what to expect.
How bad would it be?
At the very least, there would be a huge selloff on Wall Street. In its latest analysis, UBS says the S&P 500 could fall by at least 20%.
But it's hard to predict just how bad things could get because the U.S. has never defaulted on its debt.
Analysts believe the selloff could match or surpass a precipitous drop in September 2008, when the House of Representatives rejected a $700 billion rescue package as the U.S. was on the precipice of the global financial crisis.
The Dow Jones Industrial Average dropped about 778 points that day, which was then the largest single-day drop by points in the index's history.
A default would also send the U.S bond markets sharply lower.
Treasurys have been seen as some of the safest investments worldwide. They are held by companies and countries the world over and used as collateral in all kinds of financial transactions. If the federal government failed to pay bondholders, it would have unimaginable consequences for the standing of the U.S.
A default would also weaken the U.S. dollar, which is widely seen as the world's most important currency given the critical role it plays in the global economy.
"The world's main reserve currency and the world's 'safe' asset, which form the bedrock of the global financial system, are suddenly a lot less safe and should be repriced," UBS economists wrote in a May 19 note to clients. "How that cascades through the system is unpredictable."
Analysts also believe credit ratings agencies would downgrade the country's credit rating.
Currently, the U.S. has a "AAA" rating from two of the three major credit agencies. The U.S. suffered a downgrade in 2011 from the other major ratings company, when S&P Global Ratings lowered the country's rating to AA+ amidst another round of debt negotiations under President Obama.
How would the market turmoil affect me?
Most obviously, a sharp drop in stocks would hit retirement or other investment funds across the board. At the same time, bond markets determine all kinds of borrowing costs, which would go sharply higher if there were a U.S. default.
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 hiked interest rates aggressively to fight high inflation. Mortgage rates, for example, would climb even higher, as would interest rates on credit cards.
Inflation has cooled some, but it is still nowhere near the Fed's 2% target, and many economists expect the U.S. is headed for a recession. On top of that, there is still turmoil in the banking sector after the recent failures of three regional lenders.
"There are already significant pressures on the U.S. economy," says Seema Shah, the senior global investment strategist at Principal Global Investments. "It cannot afford to have another major shock landing on its head."
Shah echoes what policymakers have said, that a government default would not only kickstart a domestic recession, but also potentially another global financial crisis.
Is this how it's going to be?
As long as the U.S. has this limit on how much it can borrow, it seems likely.
Lawmakers have voted to raise the debt ceiling more than 100 times, but debates about the debt limit have become increasingly fractious and used as a political weapon.
In recent days, business leaders have gotten more engaged with the process.
On Thursday, Treasury Secretary Janet Yellen met with dozens of bank CEOs, while more than 100 executives wrote a letter to President Biden and congressional leaders, warning them of the consequences of inaction and encouraging them raise the debt limit.
"Action to end the pending debt crisis is necessary now," they wrote, noting a default "would weaken our position in the world financial system."
"We strongly urge that an accord be reached quickly so that the country can avert this potentially devastating scenario.
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