The pressure is mounting for U.S. politicians to reach a deal that would allow the government to keep borrowing money to pay its obligations. The consequences of not reaching an agreement on the debt ceiling could be disastrous—not just for the United States but also Canada. However, while financial markets are currently under stress, a resolution is expected with an accompanying rebound.
BMO senior economist Sal Guatieri told The Epoch times that the current debt ceiling impasse’s impacts are creating tighter financial conditions in Canada—falling stock markets and rising bond yields—which would constrain spending if it continued.
“We will also get some impacts on confidence—business and consumer confidence—more so in the U.S., but also in Canada, and that almost certainly most likely would tip us into a recession,” Guatieri said.
Markets in the last week have been under siege with stocks down roughly 2 percent and bond yields higher by about 20 basis points or 0.2 percentage points. Currencies are also falling and the VIX—a measure of stock market volatility—rose above the 20 level for the first time in three weeks on May 24.
The shortest maturity U.S. treasury bills are yielding above 6 percent like junk bonds. The U.S. three-month treasury bill yielded 5.33 percent on May 24—much higher than the two-year treasury note yield of 4.36 percent and at a post-2001 high, according to Deutsche Bank.
Most economists are already anticipating a mild economic downturn from the effects of significantly higher interest rates and Guatieri says a short period of the United States defaulting on its obligations would increase considerably the odds of a recession .
But if an agreement is reached before the so-called “X-date” in early June—where the U.S. government can no longer pay its bills and defaults on its debt—the effects on markets and the economy could reverse quite quickly, Guatieri added.
Any deal that’s reached has to be passed through both houses of Congress. The situation remains fluid.
‘Like a Non-Issue’
Despite the turmoil in financial markets, Richard Dias, founder and head of research at Acorn Macro Consulting Ltd. says the debt ceiling is “like a non-issue.” Since its inception, the ceiling has been going up no matter what political party is in power, he said in an interview on May 24.
Dias is a global macro strategist who helps institutional investors with their asset allocations.
While China has designs on its yuan rivalling the greenback as the world’s reserve currency, Dias says, “The U.S. is the most important global economy in the world. All this chitter chatter about how the reason they’re going to lose reserve currency status is just total baloney.”
The point he makes is, “if you had a billion dollars, would you deposit it in a Chinese bank? Neither would the Chinese billionaires that are desperate to get their money out.”
“That’s really the point.”
The widespread expectation is that Democrats and Republicans will come to an agreement, although it might come at the 11th hour.
The U.S. government is not like a household in that it can’t delay payments to government employees, national defence and social security, said Oxford Economics chief U.S. economist Ryan Sweet in a May 24 note.
“This isn’t the first time the Treasury Department has flirted with hitting the debt ceiling and it won’t be the last,” he said.
Warning
The U.S. debt ceiling conundrum highlights an issue of keeping debt at sustainable or manageable levels.
Oxford Economics (OE) noted in a May 23 research piece that government interest expenses are rising at a worrying pace across advanced economies. For the U.S., OE notes that total federal interest costs rose to US$1.1 trillion in April.
“It is a reminder, I think, for governments to keep an eye on their deficits. The U.S. situation is very particular to the U.S.—other countries do not have a so called debt ceiling that they either have to lift or suspend for a period of time,” Guatieri said.
The U.S. deficit as a percentage of GDP is about 6 percent, having recovered from over 15 percent during the pandemic.
Canada is in better fiscal shape, with a deficit-to-GDP ratio projected to ease below 1 percent in the next couple of years, according to the government’s Budget 2023 projections. But Canada’s interest expense as a percentage of GDP is projected to soar.
Dias criticized governments running large deficits without inputting plans for cutting spending, which is also forcing credit rating agencies to consider lowering ratings on federal debt. That would, in turn, raise borrowing costs for governments.
“I would love for the bond market to punish governments for misbehaviour,” Dias said.
