Debt Ceiling will be a Wet Blanket Over the Stock Market Until June’s X-Date

The markets are already very concerned about the upcoming showdown over the debt ceiling, which may need to get to the point at which a plunging stock market finally convinces politicians to raise the debt ceiling.  In Washington, one of the few things that get politicians’ full attention is a stock market meltdown.

The Treasury hit the debt ceiling today and is starting to use extraordinary measures to avoid running out of borrowing authority and cash.  However, Treasury Secretary Yellen has said that sometime after early-June, the extraordinary measures will no longer work, and the Treasury will run out of borrowing authority and cash, forcing it to begin failing to pay all of its financial obligations.  If there is no hike in the debt ceiling by that so-called “X-date,” then the crisis will begin in earnest since the Treasury will have only incoming tax revenues to pay for its obligations.

Even in the run-up to the June X-date, however, investors are likely to take a cautious stance and are unlikely to go on any buying sprees, meaning the debt ceiling is likely to hang like a wet blanket over the stock market for the next several months. 

There is no doubt that the debt ceiling will eventually be raised.  Without a debt ceiling hike, the U.S. government will not have the authority to borrow any more money and will be unable to pay all the obligations that Congress has already agreed to pay, such as salaries for the military and other government employees, Social Security, health care payments under Medicare, transfers to states, public aid, and many other obligations.

Most importantly, the U.S. Treasury may not have enough cash to pay interest and principal on Treasury security debt, which would constitute a sovereign debt default and put the U.S. in a position similar to that of serial dead-beats like Venezuela and Ecuador. The U.S. already lost its AAA credit rating from S&P the last time there was a debt ceiling meltdown in 2011.

The 2007-09 global financial crisis taught the markets that defaults and insolvencies can quickly spiral out of control in unpredictable ways and bring the global financial system to its knees.  A U.S. sovereign debt default could cause a cascade of defaults, runs, and collapse of various markets, funds, and financial institutions.  Since Treasury debt is held widely throughout the world and the dollar is the world’s primary reserve currency, a Treasury default would immediately become a global crisis. 

House Republicans are trying to argue that the Treasury will be able to prioritize its payments after the X-date so that it can pay Treasury security interest and principal first with the tax revenue it has coming in and refuse to pay less important obligations. If the Treasury uses the limited amount of incoming tax revenue it has to pay for Treasury securities first, then politicians could, in theory, push the crisis for days or weeks, if they are willing to take the political heat from a stock market meltdown and missing Social Security payments.

However, in debt ceiling clashes in the past, the Treasury has argued that it has neither the operational capability nor the legal authority to prioritize Treasury debt payments over other obligations such as Social Security payments or military salaries.

The markets are hoping they will not find out whether the Treasury can find a way to prioritize Treasury security payments to avoid a sovereign debt default if the debt ceiling is not raised by the X-date, or whether the White House or the Treasury has some other trick up their sleeves to avoid default.  If there is a sovereign Treasury default, the markets may face yet another systemic global financial crisis, this one entirely engineered in Washington.

• Economic Concerns and Debt Ceiling Risk Weigh on Stocks
• An Uptick in Options Volume for Zoetis (ZTS) Points to a Potential Opportunity
• Markets Today: Stocks Lower on Recession and Debt Ceiling Risks
• This Option Trade Profits If Amazon Stock Stays Above 82