Debt Ceiling Scenario
May 22, 2023
Debt ceiling scenario #1: A short-term extension to August is the most likely scenario given the estimated ex-date of June 1 and time required to produce a bill. Even a two week extension would get the Treasury to the June 15 corporate tax deadline with receipts likely to fund the government until an additional ~$140B of extraordinary measures become available on June 30. This is the most bullish short-term scenario for equities by keeping bond yields from repricing higher, easing dollar strength and keeping the Fed on hold at the June meeting. Markets began pricing for this outcome late-last week.
Debt ceiling scenario #2: A long-term agreement to raise the debt ceiling with large cuts in federal spending would likely result in higher bond yields as markets shift back to tracking macro fundamentals. Removing the risk of a technical US default would be a positive development, but higher yields would likely pressure equities lower. A long-term agreement would lead to a surge in T-bill issuance and drain liquidity away from equities. In this scenario, we see 10-year yields moving into the 3.90% range, resulting in S&P 500 (SPX) downside of ~2.5%.
Debt ceiling scenario #3: This is the no-deal scenario that results in a short-term technical default. We’d expect a sovereign credit rating downgrade to occur several days before a technical default. There have been two US credit rating downgrades in 2011 and again in 2013. Both caused a flight to quality move that resulted in lower bond yields, higher dollar, higher gold prices and lower stock prices. The credit rating downgrade from 2011 triggered a ~4.8% single day decline in the SPX and a peak to trough decline of ~20%. An actual US default would also lead to a crisis of confidence and single day risk-off event for equities. The single-session downtick would likely be larger than 5% and the peak-to-trough decline would be larger than 20%.