Debt ceiling crisis is already changing market dynamics - what could come next?
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While most investors are expecting an 11th-hour deal to be reached over the debt ceiling, interesting market dynamics are at play as the drama unfolds in Washington. Some triple-A corporate bonds from Microsoft (NASDAQ:MSFT) and Johnson & Johnson (NYSE:JNJ) are trading at a yield discount to Treasury bills, which are generally viewed as the most safe investment in the world. In fact, Wall Street just witnessed the busiest week of the year for investment-grade corporate bond issuance, helped by a $31B debt sale by Pfizer (NYSE:PFE) that became the fourth largest on record.
Where things stand: Following an hour-long talk on Monday evening, President Biden and House Speaker Kevin McCarthy agreed that both sides will keep negotiating on a debt limit plan to avoid default, though they didn't reach any agreement. "I believe we can still get there," McCarthy declared, though he's not considering the president's suggestion to cut the deficit by increasing taxes for the wealthy or closing tax loopholes for the pharma and oil industries. Instead, he's focused on reducing spending in the FY2024 federal budget following a reported agreement to cut unspent pandemic funding.
The chance of a default occurring is "very, very small, but not zero," explains John Mason in a new SA article that examines the probabilities. SA analyst David Lerner adds that the "scare" could be the last best chance to get into this rally, while Investing Group Leader Mott Capital Management writes that a deal may lead to a giant stock market liquidity drain.
What would happen if the U.S. defaults? Moody's Analytics forecasts "spiking interest rates and plunging equity prices," as well as the freezing up of short-term funding. Volatility might also send shockwaves throughout the financial system, spreading to the derivative and mortgage markets, where Treasuries are often used as collateral for securing trades and loans. The focus would then turn to the Federal Reserve and its backstop menu of options to avert a calamity, but Chair Jay Powell has repeatedly warned that "no one should assume that the Fed can protect the economy."
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