Markets cautiously monitoring US debt ceiling talks as deadline looms

US officials have said they are confident of reaching an agreement before June 1

If the US fails to reach a deal, US and global stocks could dive more than 20 per cent, analysts say. Nick Donaldson / Getty

Markets are keenly monitoring the US debt-ceiling discussions as investors around the world wait to see if the world's largest economy is able to reach an agreement before the deadline next week.

Global stock markets were muted on Friday as US President Joe Biden and House speaker Kevin McCarthy continued talks to reach an agreement that would raise the government's $31.4 trillion debt ceiling for two years.

Earlier on Thursday, Mr Biden maintained that the US would not default on its debt after a series of economic reports indicated growing concerns about the repercussions of not reaching a deal.

Mr Biden said he and Mr McCarthy have had “several productive conversations”.

Asia's stock markets were cautiously higher on Friday, with Japan leading the gains, while the dollar dipped slightly, although it remained close to a two-month high.

The US dollar index, which hit a three-month high of 104.31 overnight, was at 104.05 at 1pm UAE time.

“Anxiety over the debt ceiling” remains the driving force for markets and even as a deal may be forthcoming, a sell-off in Treasuries continued overnight, said Edward Bell, senior director of market economics at Emirates NBD.

“A resolution to the US debt ceiling impasse looks to be nearing with the outline of a deal emerging overnight,” he said.

“The ceiling could reportedly be raised for two years along with a cap on overall government spending. Defence spending would still be permitted to increase next year.

“However, a full deal has still not been reached, with Moody’s raising the pressure on the US, saying that if the government missed an interest payment in mid-June, then the US would be at risk of losing its 'AAA' rating.”

Earlier in the week, rating agency Fitch said it had put America's “AAA” rating, its highest rank, on negative credit watch because of increasing political disputes around the country's debt limit.

The rating watch “reflects increased political partisanship that is hindering efforts to reach a resolution to raise or suspend the debt limit” with increasing concerns over a default, it said.

“We believe risks have risen that the debt limit will not be raised or suspended before the x-date [when the US Treasury exhausts its cash position and capacity for extraordinary measures without incurring new debt] and, consequently, that the government could begin to miss payments on some of its obligations,” it said.

While the debt ceiling talks continued on Thursday, and there was, again, some optimism, “no deal has been reached and the clock is ticking louder into the June 1st deadline”, said Ipek Ozkardeskaya, an analyst at Swissquote Bank.

“The US Treasury’s cash balance fell below $50 billion on Wednesday and, as Janet Yellen warns so loudly, the US may not reach the mid-June safe zone, where the tax money will fall in, to avoid a default,” she said.

“If investors are not extremely worried about the debt ceiling talks, it’s because they know it’s just an unnecessary political theatre and that the debt ceiling will end up being raised, anyway,” Ms Ozkardeskaya said.

“But in the extreme event of a political accident, the consequences would be catastrophic. US and global stocks could dive more than 20 per cent and the US’s self-induced economic crisis would push the world economy into a deep recession by the end of the year.”

An actual breach of the US debt ceiling could cause “severe damage” to the US economy, research this month by the White House's Council of Economic Advisers found.

“If the US government were to default on its obligations – whether to creditors, contractors or citizens – the economy would quickly shift into reverse, with the depth of the losses a function of how long the breach lasted,” the council said.

“A protracted default would likely lead to severe damage to the economy, with job growth swinging from its current pace of robust gains to losses numbering in the millions.”

Meanwhile, Brookings Institution analysts Wendy Edelberg and Louise Sheiner also said that “worsening expectations regarding a possible default would make significant disruptions in financial markets increasingly probable” and that “such financial market disruptions would very likely be coupled with declines in the price of equities, a loss of consumer and business confidence, and a contraction in access to private credit markets”.