Many investors are concerned that with the far-right wing of the Republican Party holding sway in the House of Representatives, a debt default is coming.
If the view of Ralph Axel, rates strategist at Bank of America, is correct, they have good reason to be concerned.
“We think it is likely that by late summer or early fall, the federal government will temporarily be forced to default on a portion of its daily obligations for a time ranging between a couple of days to a few weeks,” he wrote in a commentary.
“If so, this would represent the first time in history that the U.S. would default on any of its obligations due to the debt ceiling law. We think such an event would include a fall in equity and bond prices, potentially testing Treasury market functioning and liquidity.”
That may be an understatement. It wouldn’t be surprising if investors absolutely freaked out, dumping assets by the bucketful.
“Potentially testing Treasury market functioning and liquidity” may sound technical and anodyne. But it’s possible the Treasury market would temporarily collapse.
Axel Foresees Treasury Payment Prioritization Plan
Still, “we would expect Treasury to quickly announce a payment prioritization plan which should protect debt from any defaults and calm markets,” Axel said. That certainly sounds reasonable. Investors have to hope he's right.
“We think any decline in asset prices entering into a default would be a buying opportunity, as the debt ceiling would eventually be raised,” he said.
“And the economic damage done from operating the government in default would be minimal on an aggregate basis if it is relatively short-lived.”
Again, that sounds plausible, and with any luck, Axel is right. But there's no guarantee with political extremists running amok.
In theory, it shouldn’t be difficult to cobble a coalition of nearly all the Democrats along with a few Republicans to raise the government debt ceiling.
GOP Collaborators Might Face Resistance
But any Republican joining that effort might be subject to a primary challenge from someone on the extreme right. And it could be worse: Those Republicans could be targeted for physical violence.
Axe says that “marketable Treasury debt would likely not experience any defaults at all, and this would be key to an orderly restoration of markets after the initial shock fades,” he said.
“The total cost of marketable debt is not only small relative to other government obligations. But it would likely be prioritized over all other payments in the Treasury payment system.”
Further, “we would expect the Treasury Department to announce a prioritization plan before entering the default zone,” Axel said.
Yellen: Debt to Hit Current Limit on Jan. 19
Treasury Secretary Janet Yellen wrote a letter to Congress Jan. 13, announcing that beginning Jan. 19, "the outstanding debt of the United States is projected to reach the statutory limit."
Further, "once the limit is reached, Treasury will need to start taking certain extraordinary measures to prevent the U.S. from defaulting on its obligations," she said.
"The period of time that extraordinary measures may last is subject to considerable uncertainty," Yellen said.
"It is unlikely that cash and extraordinary measures will be exhausted before early June.... I respectfully urge Congress to act promptly to protect the full faith and credit of the United States."