An Inopportune Time

HIGHLIGHTS:

• The debt ceiling negotiations remain gridlocked as the supposed June 1 deadline fast approaches.
• A scenario where the Treasury must cut spending to meet obligations over a short period could result in an 8 percent decline in US GDP.
• Higher-than-expected inflation in Europe and a new wave of COVID in China are adding to pessimism over global growth.
• The US economy is already strained under higher consumer prices and increased borrowing costs, and debt limit issues are only adding further burden.

Financial markets continue to churn after each debt ceiling negotiation update. Shares climbed last week as optimism reigned amid rumors of a weekend deal. This week, however, the market mood has soured as policymakers and the White House remain gridlocked over the same issues. The lack of progress is causing growing anxiety as the alleged June 1 default deadline fast approaches.

The most likely scenario is negotiations come down to the wire and participants—on one side or both—are forced into a painful compromise. In that case, crisis would be averted and the debt limit extended, even if for a shorter period than normal. However, consequences for cutting it too close exist, as the 2011 US credit downgrade proved. In an environment of increasingly polarized politics, a no-deal outcome may seem more likely than ever, but it remains a very low probability. If negotiators can’t reach a deal, it would force the US Treasury to cut spending to meet debt obligations. According to Bloomberg, that in itself would cause an 8 percent decline in GDP by conservative estimates, not to mention other economic effects and financial market turmoil. Investors will keenly wait for news of a resolution.

Dawdling over the debt limit couldn’t come at a worse time as the US and global economies delicately press forward amid surging consumer prices, higher borrowing costs, and the threat of recession. The UK’s FTSE 100 Index—the largest 100 stocks in the London Stock Exchange—tumbled 1.75 percent today after a higher-than-expected 8.7 percent inflation print. Meanwhile, shares in China’s CSI 300 Index continued to decline as developer debt issues grow and a new wave of COVID added to growth worries.

Many of investors’ ongoing concerns come at an incredibly inopportune time. The US economy is already strained as consumers feel the weight of higher prices, while the financial system continues to absorb the 500-basis-point increase in borrowing costs the Fed made over the past year. Uncertainty over the debt ceiling only adds multiple headwinds causing concern for the growth outlook. Congress and the White House reaching a resolution and being able to put the issue behind us will be a welcome step forward for investors.

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