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June 5, 2023

Chart of the Week: Market uncertainty and the US debt ceiling

by Fathom Consulting.

The uncertainty over the future of the US debt ceiling and the risk of a US default have caused the US sovereign one-year CDS spread, an indicator of sovereign credit risk, to soar in the last few months. The spread peaked at 152 on 2 May, the highest it has ever been. The spread remained high until it became clear that a deal would be struck, after which it dropped by 90 basis points between 30 May and 1 June. Standoffs are not new: the debt ceiling issue has been used both by the Republican and Democratic side in the past to forward their political agenda. The consequences for the bill not passing would be severe which makes withholding approval effective, albeit risky, leverage. But this market reaction in the CDS spreads is the largest it has ever been to a debt ceiling standoff, much larger than during the debt ceiling crisis in 2013 when the government was shut down for 16 days and an agreement was finally passed just in time, with the Treasury Department stating that it could run out of money within a day. This exaggerated market reaction probably reflects concern about the extent of the division between Republicans and Democrats, which has been unusually wide in recent years. This division increased the risk of an accidental default due to political brinkmanship, with one side overestimating their position and not reaching an agreement in time. There was also concern over whether the US would run out of money sooner than expected due to weaker than expected tax revenues this year, also triggering a default.

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