US could see a fight over debt ceiling that rocks markets, Goldman Sachs warns

New york
CNN Business

Republicans and Democrats are likely to clash next year over the debt ceiling, a fight that could roil financial markets, upset consumers and scare the economy with the prospect of default.

The looming debt battle in Washington could cause uncertainty since the 2011 brinkmanship arrest that cost America its perfect AAA rating and caused chaos on Wall Street, Goldman Sachs warned clients in a note on Monday.

“To raise the debt ceiling next year, bipartisan support will be necessary but difficult to achieve,” the Goldman Sachs economist wrote in a statement.

“Debt debt” is exactly what it sounds like – the maximum that the federal government is allowed to borrow, after Congress set a threshold more than a century ago to limit government borrowing. But as alleged, Congress has in the past raised the debt limit to prevent a US debt default that economists warned would be “fiscal Armageddon.” That’s what lawmakers did in late 2021 after a final stand on the debt ceiling.

Goldman Sachs says there have been “more false alarms in the last decade than real close calls.”

Washington also met last week to reach an agreement that averted what could have been a catastrophic rail strike.

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But Republicans have signed up to a brewing fight over the debt ceiling.

GOP House Leader Kevin McCarthy, who is running for Speaker of the House, told CNN before the midterm elections that Republicans will seek spending cuts to raise the debt ceiling. Republican Senator John Thune of South Dakota told Bloomberg last week that the debt ceiling could be a way to reduce the budget.

That sets the stage for risky currency exposure that puts the US at risk of default, or at least a close call.

“We remain concerned that the regulatory powers will lead to a financial struggle that could include a debt default by mid-2023,” Isaac Boltansky, director of policy research at BTIG, wrote in a note to clients this weekend.

Goldman Sachs noted that the political environment next year will have “echoes of 1995 and 2011” – the two most crowded situations over the debt ceiling in recent history. The report said most, though not all, of these conflicts occurred when Republicans controlled at least one chamber of Congress during a Democratic presidency.

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“Next year will provide political and financial conditions with another disturbing conflict, with a razor-thin majority in both chambers and high inflation can increase uncertainty,” Goldman Sachs wrote in a report. “Although it is difficult to predict, it seems unlikely that the deadline for the end of the debt next year will create as much uncertainty as the experience of 2011, but there is a good chance that it will be closer than at any time since then.”

A close call could end the chaos on Wall Street that is causing losses in the retirement accounts and investment portfolios of everyday Americans.

“It seems that the uncertainty about the debt limit in 2023 can lead to great volatility in the financial markets,” Goldman Sachs economists wrote, noting that the standoff in 2011 helped cause a deep selloff in the American market.

Beyond the markets, Goldman Sachs said failure to raise the debt limit on time “would pose a greater risk to government spending and ultimately economic growth than would Treasury securities themselves.”

That’s because in order to prevent a US debt default, the federal government will change money to continue paying interest on Treasuries. That would create a huge hole that could be filled by delaying a host of other payments – including those millions of Americans rely on such as federal workers’ compensation, veterans’ benefits and Social Security payments.

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Goldman Sachs wrote:

The good news is that Washington appears to have plenty of time to reach a compromise on the bill before things get dicey.

Economists at Jefferies said in a recent research report that default risk is unlikely to appear until “at least” the end of September next year.

Although federal debt is likely to reach the official limit in the next few weeks, Goldman Sachs said the Treasury Department should be able to borrow as usual until late February or early March. At that time, the government can find stocks of 500 billion dollars to cover the deficit until August.

Furthermore, there is much uncertainty about exactly when default risk may arise due to many moving factors, including student loan payments and income taxes.

“Funds could run out quickly in July and late October,” Goldman Sachs said.


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