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Investors, executives and economists are preparing contingency plans as they weigh the potential turmoil from a default in the $24 trillion U.S. Treasury market.
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go throughjoe renison
The U.S. debt ceiling has been reached, and the Treasury is working onFind ways to save cash. After the exercise runs out, what previously seemed unfathomable may become a reality: a U.S. default.
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The far-reaching effects are hard to fully predict: from shockwaves in financial markets to bankruptcies, recessions, and potentially irreversible damage to countries long at the center of the global economy.
The likelihood of default remains low, at least based on assurances from lawmakers against opposition that a deal will be reached to raise or suspenddebt limitand the high odds implied in certain financial market transactions. But as the day looms when America starts running out of cash to pay its bills, it could beJune 1 at the earliest— Investors, executives and economists around the world are considering what might happen before, during and after, making contingency plans and deciphering largely untested rules and procedures.
"We're navigating uncharted waters," said Andy Sparks, MSCI's head of portfolio management research.
On the cusp of violations, "horror scenarios" emerged.
some corners of the financial marketthey've started shaking, but those ripples pale in comparison to the waves that form when a default approaches. The $24 trillion U.S. Treasury market is the government's main source of financing and is the largest debt market in the world.
The Treasury market is the backbone of the financial system, a building block for everything from mortgage rates to the dollar, the world's most widely used currency. Sometimes, treasuries are even considered cash equivalents because of the guarantee of government solvency.
Destroying confidence in such an entrenched market would have hard-to-quantify effects. Most, however, think a default would be "catastrophic," said Calvin Norris, portfolio manager and rates strategist at Aegon Asset Management. "That would be a scary scene."
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Late payments can trigger a deal frenzy as markets start to unravel.
The government pays its debts through banks that are members of the federal payment system called Fedwire. These payments then flow through market channels and end up in the accounts of creditors, including individual savers, pension funds, insurance companies, and central banks.
If the Treasury Department wants to change the date on which payments are made to investors, it needs to notify Fedwire the day before the payment is due, so investors know the government is about to default the night before it happens.
Analysts at TD Securities said more than $1 trillion in U.S. Treasury bonds maturing between May 31 and the end of June could be refinanced to avoid default. There are also $13.6 billion in overdue interest payments, spread over 11 dates; that means the government has 11 different chances of missing a payment in the next month.
The payment system Fedwire shut down at 4:30pm. rice. If the payments due are not made now, at the latest the market will start to collapse.
Stocks, corporate debt and the dollar could plummet in value. Volatility can be extreme, not just in the United States, but around the world. In 2011, when lawmakers struck a last-minute deal to avoid defaulting on the debt ceiling, the S&P 500 fell 17% in just two weeks. Reactions to violations can be more severe.
Perhaps counterintuitively, some Treasuries are in high demand. Investors may dump any imminent maturities (for example, some money market funds have already traded their holdings of June maturities) and buy other future maturities, still viewing them as a safe haven stress period.
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The string of downgrades has created a "boom" for bondholders.
Joydeep Mukherji, lead analyst for U.S. credit ratings at S&P Global Ratings, said late payments would cause the government to be considered a "selective default," so it opted to default on some payments but was expected to continue paying other debts. Fitch Ratingsalso saidThe government would be downgraded in a similar fashion. These ratings are typically assigned to distressed companies and government borrowers.
Another major rating agency, Moody's, said that if the Treasury defaulted on interest rates, its credit rating would be downgraded by one notch, slightly below its current top rating. A second failure to pay interest will result in another downgrade.
Many government-linked issuers could also be downgraded, from institutions that support the mortgage market to hospitals, government contractors, railroads, energy utilities and defense companies that rely on government funding, Moody's said. It would also include foreign governments, such as Israel, that guarantee their own U.S. debt.
Some fund managers are particularly sensitive to rating downgrades and could be forced to sell their holdings of U.S. Treasuries to meet rules on the minimum debt rating they can hold, which would drive down their prices.
“I’m afraid that in addition to first-order madness, there’s second-order madness: like, if you get two of the three major rating agencies to downgrade something, you’ve got a bunch of financial institutions that can’t hold those values.” Federal Reserve Bank of Chicago Governor Austan Goolsbee said at an event in Florida on Tuesday night.
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Pipelines in the financial system freeze, making transactions more expensive and difficult.
Importantly, according to the Securities and Financial Markets Industry Association, an industry group, a default on one government note, note or bond does not trigger a default on all government debt, a so-called "cross-default." This means that most of the government's debt will remain liquid.
That should limit the impact on markets that rely on Treasuries as collateral, such as trillions of dollars in derivatives contracts and short-term loans called repurchase agreements.
Notwithstanding, any warranty affected by a breach must be replaced. CME Group, a large derivatives clearinghouse, said that while it has no plans to do so, it could ban the use of short-term Treasury bills as collateral or discount the value of certain assets used to collateralize trades. .
The plumbing of the financial system is at risk of freezing as investors rush to reposition their portfolios and the big banks that facilitate the deal exit the market, making it difficult to buy or sell almost any asset.
In the turmoil of the days following the default, some investors may have received a huge windfall. After a three-day grace period, about $12 billion in credit-default swaps, a protection against bond defaults, can be activated. Payment decisions are made byIndustry CommitteeThese include big banks and fund managers.
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The country's global financial reputation is permanently damaged.
As the panic subsides, confidence in the nation's crucial role in the global economy could be permanently shaken.
Foreign investors and governments own $7.6 trillion, or 31 percent of all U.S. national debt, making them crucial to the favorable financial conditions the U.S. government has long enjoyed.
But holding U.S. Treasuries could become riskier after a default, making it more expensive for the government to borrow for the foreseeable future. The dollar's central role in world trade could also be weakened.
Higher government borrowing costs would also make it more expensive for companies to issue bonds and borrow money and raise interest rates for consumers who take out mortgages or use credit cards.
economically, according towhite house forecastEven a brief default would result in the loss of 500,000 jobs and a mild recession. A prolonged default would take those numbers to a devastating 8 million job losses and a deep recession with an economic contraction of more than 6%.
These completely unknown but widely seen as huge potential costs are what many believe will drive lawmakers to a deal on the debt limit. "Every leader in the room understands the consequences if we don't pay the bill," President Biden said Wednesday during negotiations between Democrats and Republicans.strengthen"This country has never defaulted on its debt and never will," he added.
Joe Rennison covers financial markets and trading, at a pace that goes from documenting the vagaries of the stock market to explaining trading decisions that are often difficult for Wall Street experts to understand. @Jalen Neeson
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