Markets and G7 holding their breath for the US default: this is why uncertainty is rising

Once again the US debt ceiling crisis erupts onto the global stage. And it does so just as President Joe Biden arrives at the G7 meeting in Hiroshima. Negotiations to avoid the worst-case scenario continue, with House Democrat leader Hakeem Jeffries reassuring that an agreement is coming soon. The same explains the speaker of the House, the Republican Kevin McCarthy. But in the meantime, the nervousness of the financial markets remains high. To such an extent that Jamie Dimon, number one of JPMorgan Chase, and the other top bankers on Wall Street will take stock of the Senate dem leader, Chuck Schumer. The risk, if the negotiations fail, is a domestic recession that could destabilize the global economy.

The default issue continues to dominate international investor discussions. To such an extent that it will be one of the central themes of the Japanese summits. Treasury Secretary Janet Yellen has repeatedly stressed that Washington cannot fail the debt negotiations. Biden will also repeat it, who has already intervened on the issue on the eve of the G7. “If America defaults, nearly eight million Americans could lose their jobs and we’ll end up in a recession. It’s not an option,” the President of the United States, Joe Biden, wrote on Twitter as he left for the Japanese summit. Biden will give up his stops in Australia and Papua New Guinea to return to Washington as soon as possible to seek an agreement with the Republicans on the debt ceiling and avoid default. “Party differences haven’t stopped Congress from avoiding default, so far. They shouldn’t even now,” Biden explained.

The markets are holding their breath, because by 1 June in the event of no agreement, the country will no longer be able to honor its obligations. And it would be directed towards a de facto halt to all federal activity. According to the Congressional Budget Office, the US national debt now exceeds annual GDP, will soon surpass record post-World War II debt-to-GDP levels and is on track to reach 135% of GDP by 2040. Per Josh Lipsky, director of the Geo-economic Center of the Atlantic Council, the issue of the debt ceiling will be added to the hot topics of the summit of the “large”, together with Russia, Ukraine and China. “It’s extraordinary – he explains – often the G7 has an economic issue in the foreground, whether it’s the global financial crisis or the eurozone crisis, or it has a military or geopolitical issue. This year it will have both”. And this could have a major impact on the external perception of the United States.

What is certain is that the risks are increasing. According to Russel Matthews of RBC BlueBay, “although it is too early to position for the event, the most likely outcome will be a ‘risk-off’ period driven by fears of a default-type event or a rapid and severe reduction of public spending that makes the market predict a more serious economic recession”. All in a context in which the American banking segment is under extreme pressure. If one looks at the Silicon Valley Bank crisis, Matthews explains, “it is interesting to note that Jerome Powell, chairman of the Federal Reserve, at the beginning of March was talking about the trajectory of growth and inflation and wanted to impose a hawkish change of pace in determining the Fed’s rate hike path. It is evident, he stresses, that the Fed “did not expect the chaos that would later erupt in the US regional banking sector”. The problem is that this crisis, which is added to that of the debt ceiling, can be instrumental in increasing the chaos. “We take this surprise as a warning sign that stress can emerge out of nowhere, associated with sectors of the economy and financial system that no one suspects. We believe the market is worrying too little about this eventuality.” As a result, concludes Matthews, “we will face further volatility this year”. That could increase should the debt ceiling negotiations drag on beyond the beginning of June. Remote hypothesis, but not impossible.