What happens on June 1?
The US government will run out of money… unless the country’s President and House Speaker agree on a deal.
As of writing, they haven’t yet.
Investors are wondering… what happens if there is no deal?
Let us walk you through the consequences.
If the US Gets into a Technical Default, What Will Happen to the Markets?
In short, prepare for a bumpy ride.
Stocks wouldn’t do well. Volatility could increase.
When investors are scared, they rush into “safe havens” such as the US dollar, gold, and Treasury bills.
Yes, even in the case of default, Treasuries could actually rise in price.
This would push down interest rates. (Yields and prices are inversely related.)
Wall Street analysts point out that Treasuries rallied during the 2011 and 2013 debt ceiling negotiations.
What Would Happen to the Economy?
Nobody knows what would happen exactly.
However, there are macro models that provide some estimates as to what investors should prepare for if the debt ceiling talks stall.
A Bloomberg model estimates that the spending cuts that the Republican negotiators insist on might potentially cost about 570,000 jobs across the economy, for example.
A more pessimistic scenario projects that the US GDP could drop by 1.8% to 8% in the second half of 2023.
In other words, if the debt ceiling talks fail, the country’s economy might dip into a recession this year.
What Is the Market Pricing In?
Investors can understand market expectations by looking at certain indicators.
Debt securities that are due in early June, and that are at the highest risk of default if the debt negotiations fail, show a significant risk premium.
This means that investors take the possibility of default seriously and price the bonds that are most at risk accordingly.
For example, some of the securities maturing in early June have a yield of 6%. That’s four percentage points higher than the ones maturing in late May.
Another number investors look at is the price of credit default swaps.
They act as insurance against a default. If the probability of a default is deemed high, they go up in price.
So far, the prices of credit default swaps, which are used to insure US debt, have soared. The cost of insuring US debt is now higher than that of Greece, Mexico, and Brazil. All three defaulted multiple times.
What Could Investors Do?
They should use this opportunity to accomplish two things.
First, diversify their portfolios. Now is the time to take a look at gold and other “safe haven” investments that tend to perform well during times of high volatility.
This volatility could last longer than June 1. We wouldn’t be surprised to see it last for a quarter or two after that.
Taking advantage of any selloff in the broad markets would also make sense. But only provided that the assets you put on your radar as potential buying opportunities have strong support from long-term trends.
We will continue monitoring the debt debate on your behalf and update you on the opportunities we see.
Thank you for your loyal readership,
The Financial Star team