Credit Suisse warns that debt ceiling impasse will likely prove 'stressful' for markets

Published Wed, Feb 8 20231:24 PM ESTUpdated Wed, Feb 8 20232:14 PM EST

The debt ceiling battle shaping up in Congress is unlikely to get settled until later in the year and will probably cause market damage in the meantime, according to Credit Suisse. Republican "Freedom Caucus" lawmakers looking for spending concessions are likely to be the main obstacle to a resolution, Ray Farris, Credit Suisse's chief economist for the Americas, wrote in a client note. "Freedom Caucus power within the House is disproportionate to the group's small numbers," Farris said. "A resolution is unlikely any time soon." The government hit its $31.38 trillion debt limit on Jan. 19. Since then, the Treasury Department has used measures at its disposal to continue funding operations and likely can continue to do so for months. In Farris' view, that offers little incentive for GOP stalwarts to budge until Treasury hits the "X-date" when it no longer can fund the government. That could come as soon as June or as late as early October, according to various estimates. Farris thinks the issue ultimately will get resolved, but not before doing some real market damage in the form of higher bond yields and volatile conditions. In the event of default, bond yields likely would rise while rating agencies would downgrade U.S. credit, he added. "We expect Congress to ultimately raise the debt ceiling. However, we see risk that greater upward pressure on Treasury security yields will emerge as tension increases ahead of the X-date," he wrote. "Conditions are in place to make the journey to a debt ceiling increase difficult and increasingly stressful for markets." Spreads on credit default swaps have started to widen, but Farris suggested they may have further to go as they are still not at the level where they stood during the last major debt ceiling impasse in 2011. "Markets have begun to price default risk but may need to price more," he said. President Joe Biden mentioned the debt ceiling debate during his State of the Union speech Tuesday night, even suggesting that some Republicans wanted to sunset Medicare and Social Security, a charge that earned him catcalls from GOP members in the House chamber. "Let us commit here tonight that the full faith and credit of the United States of America will never, ever be questioned," Biden said. But Farris said dire warnings about the debt ceiling breach "have become less credible." He cited transcripts from 2011 calls between Treasury and Federal Reserve officials indicating that the central bank also had measures it could implement to keep the government afloat. Still, Farris stressed that market dangers loom. "A default due to failure to raise the debt ceiling would be a willful political decision," Farris wrote. "The clear risk is that markets would respond with a larger, more persistent increase in yields that stretches beyond T-bills into notes and bonds." Treasury yields have moved higher since spending hit the debt ceiling. However, that also has coincided with a quarter percentage point interest rate hike from the Fed.