You might expect the stock market to rise after the White House and House Republicans reached a tentative deal to raise the debt ceiling, but markets may have other plans.
The stock market, for the most part, has ignored the serious risks associated with the US defaulting on its debt. Even if Congress passes a bill to raise the debt ceiling and President Joe Biden signs it, stocks and other financial markets could take months to recover.
“One of the concerns that I have is that in the run-up to an agreement, when one happens, there could be significant financial market distress,” Treasury Secretary Janet Yellen said last week.
“We’re only seeing the beginning of it,” he said, referring to stock and bond market volatility in recent days.
House Speaker Kevin McCarthy of California speaks as he meets with President Joe Biden to discuss the debt ceiling in the Oval Office of the White House, Monday, May 22, 2023, in Washington. (AP Photo/Alex Brandon)
If the markets get what they ultimately want — no debt default — they may be in for a rough ride soon after the deal is signed.
This is because the Treasury needs to immediately replenish the money it has burned during extraordinary operations where it cannot borrow more money.
That will create more competition for equity from investors, said Michael Reynolds, vice president of investment strategy at Glenmead. After weighing their options, many investors may find more profitable investing in U.S. Treasuries than stocks. This will temporarily siphon some liquidity from the stock market, he said.
In 2011, lawmakers reached an agreement to raise the debt ceiling hours before the U.S. defaulted on the debt. Two days later, Standard & Poor’s downgraded US debt for the first time in history.
It took two months to recover the losses incurred as a result of the fall in stocks and the initial sell-off known as the X-date, when the government lacked the ability to meet all its fiscal obligations.
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“It wouldn’t be surprising if there was a repeat of 2011,” said George Mateo, chief investment officer at Key Private Bank.
While he doesn’t expect a major credit agency to downgrade U.S. debt before or after a deal to raise the debt ceiling is reached, he said the current stance could lead to a major loss of confidence in the U.S. financial system.
That’s why, even if a deal is reached, he expects months of market volatility.
“We’re not out of the woods because we’ve raised the debt ceiling,” Mateo told CNN.
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