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SA and the world hold their breaths as a US debt default looms

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Safety of US Treasuries at risk as debt ceiling standoff is prolonged and default looms.
Safety of US Treasuries at risk as debt ceiling standoff is prolonged and default looms.
Reuters/Murad Sezer

BUSINESS


US Congress members are embroiled in another fiscal standoff after the Republicans and Democrats continue to debate about raising that country’s debt ceiling above the current $31.4 trillion (R604 trillion) by June.

Failure to reach an agreement means the US would not be able to borrow more money or pay its bills. Last month, Republican speaker Kevin McCarthy introduced his party's Bill, which included their own debt increase of $1.5 trillion and significant spending cuts.

The US treasury has been releasing updates on how much money it has left in the kitty to service its obligations, with some US bills maturing in early June. It's estimated that US treasury secretary Janet Yellen and her team will have about $30 billion left of authorised expenditure by the start of June. This after a letter penned by Yellen to Congressional leaders earlier this month, stating that her department’s ability to avoid breaching the statutory debt ceiling via "special accounting manoeuvres" would be exhausted at the beginning of June.

She wrote:

After reviewing recent federal tax receipts, our best estimate is that we will be unable to continue to satisfy all of the government's obligations by early June, and potentially as early as June 1, if Congress does not raise or suspend the debt limit before that time.

This means US legislatures in both houses have a small window of two weeks at the most to get their house in order or default. Rand Swiss portfolio manager Viv Govender says the world cannot afford a US default, as US debt is the bedrock of global debt.

Around $500 billion of US debt is traded daily. 

“If the US is downgraded, then the whole world has a high-risk profile. Global commerce infrastructure that depends on the dollar is the in-between currency for most of the global trade and the number one reserve currency. A downgrade of the US would be a catastrophic event if they did default on their debt if the debt ceiling was not raised.”

 READ:  The dollar is here to stay – analysts

This is not the first time that the US finds itself on the precipice of a fiscal cliff. In 2011, Congress went down to the wire, threatening the livelihoods of civil servants and global financial stability before agreeing on raising the debt ceiling.

Lloyd Miller, co-head for financial markets at ETM Analytics, says the uncertainty around this crisis is already hurting the US economy.

We have seen borrowing costs rising already through higher US Treasury yields, potentially exacerbating what were already fragile banking conditions in the US, following the Federal Reserve’s aggressive rate hikes.

“These higher borrowing rates will filter through to US consumers through higher mortgage rates and other borrowing costs. This, coupled with still-elevated inflation, threatens consumption in the US, which drives a large portion of its economic growth. Thus, the risk of a US recession rises.

“A full default will certainly lead to a recession, with unemployment to rise sharply while business and consumer confidence levels will plunge. Government payments to its employees and its suppliers will be halted, creating massive ripple effects throughout the economy. A default-induced recession will also be difficult to reverse, with government unable to deploy any counter-cyclical policies to support the economy,” Miller said.

Markets

On Monday, the local bourse opened softer, taking a cue from the Asian markets, which struggled for direction as the world awaits the outcome of negotiations between US President Joe Biden and McCarthy and others as debt default looms. Miller says a US default would send shockwaves through global markets.  

“US Treasuries are seen as 'risk-free' and used as collateral for loans or as buffers against bank risk, underpinning the world’s financial markets. If the markets’ trust in the US government and its ability to repay its debt is damaged, it could lead to significant financial market volatility and likely loss within global equity markets.”

He added: 

For South Africa, local equities would come under pressure, with the country’s weak economic fundamentals only making any global sell-off due to de-risking worse.

The South African rand, which has come under pressure in recent weeks, firmed slightly in early trade on Monday, after dodging a downgrade from rating agency S&P Global Ratings on Friday and expectations of a 50 to 75 basis point interest rate hike by the Reserve Bank on Thursday.

Govender says the talk of default has no doubt added to uncertainty in the world and markets.  

 “I have seen people talk about a 45% drop in the stock market, but I don’t think that is true. Markets might dip a bit, but a 45% dip is unlikely. It's inconceivable that they will not pay their debt even if they did technically default; the market would assume that this is a temporary [glitch]. They would obviously be a higher risk profile, but they wouldn’t react as if South Africa had defaulted on its debt.”

READ: Brics is little more than ‘talk shop’ and can’t challenge the dollar

There have been debates about the status of the US dollar as a reserve currency, exacerbated by talk by the Brics group of countries (Brazil, Russia, India, China and South Africa) of an independent currency of trade. And this will not help as countries like China have started to reduce their US dollar reserves. Miller says a default, even if brief, would see global investors lose confidence in the US dollar and US Treasuries.

“The US dollar’s status as the global reserve currency will be impacted. A shift away from the US dollar is gradually gaining momentum, and a failure by the US to pay its debt obligations will only serve to speed this up,” he said.


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