JPMorgan on the potential risks posed by the US debt default and the impact it may have on the stock market.
In a note to clients, JPMorgan’s equity macro strategy team has highlighted the potential consequences of the US defaulting on its debt. Despite the lack of significant market movement so far, the analysis suggests that equities may be slow to price in the risks associated with a contested debt-ceiling rise and the increasing probabilities of technical default. However, as the X-date (the day the US is expected to be unable to pay its obligations) draws closer, JPMorgan warns that these risks may be abruptly re-priced, leading to a potentially “sharp” reaction in the stock market.
Lack of Market Reaction Raises Concerns
Debt ceiling fears typically start to impact stocks when the X-date is within two weeks. Treasury Secretary Janet Yellen has identified June 1 as a critical date, emphasizing the potential harm to business and consumer confidence if the debt extension is delayed. However, Goldman Sachs suggests that the X-date may not be rigid, projecting the Treasury’s cash balance to fall below $30 billion by June 8-9. While financial markets appear relatively calm for now, Goldman Sachs anticipates additional twists and expects markets to factor in more risk before the debt limit is ultimately raised.
Meeting to Extend Debt Limit Amidst Uncertainty
The article notes that past debt ceiling threats have adversely affected stocks. In 2011, ongoing debates in Washington led to a nearly 20% decline in the S&P 500. While such a significant drop is not the baseline forecast, experts suggest that a debt deal is likely to be reached in response to market pressure. However, in a worst-case scenario where the US fails to pay its coupons for a month, the S&P 500 could experience a downside of up to 30%, according to UBS.
JPMorgan emphasizes that the current economic backdrop, characterized by historically-high inflation, tightening credit conditions, and an aggressive interest rate hike campaign, makes flirting with debt default riskier than in 2011. The potential impact extends beyond the stock market, with companies benefiting from government spending initiatives possibly facing downside risks as negotiations may require concessions in spending.
The analysis concludes with two major investment implications. First, the closer we get to the projected X-date without a broadly supported resolution, the greater the potential for a substantial risk-off move in equities. Second, there is the possibility of federal spending cuts across key legislative priorities for the Biden administration.
By closely monitoring the progress of debt ceiling negotiations and their implications, investors can position themselves to navigate potential market turbulence and seize opportunities that may arise.
