Debt Ceiling Scenario Analysis
May 19, 2023
There continues to be a deep divide in the US Congress over the debt ceiling and federal spending, prompting worries that lawmakers may not be able to raise the limit in time to avoid a possible default on debt payments. Democrats want the debt ceiling to be raised without conditions attached while Republicans demand spending cuts as a condition for raising the limit and want to start negotiations in the White House. The US Congress limits how much money the government can borrow and once that limit is reached, lawmakers must raise or suspend the ceiling before the Treasury Department can issue more debt.
This has implications for global financial markets as Treasurys are considered the safest and most liquid asset in the world. A failure by the US to make a debt payment could have disastrous global effects due to the amount of Treasury debt held by foreign governments worldwide (Figure 1) and the use of the Treasurys as a global benchmark for safe haven assets. A loss of investor confidence could spur a deep selloff in US Treasurys. This would create disastrous results for the global financial markets.
Figure 1: Top Foreign Holders of US Treasurys
Source: US Treasury Department
One specific outcome would be for interest rates worldwide to increase significantly while equity prices would likely plunge. One of the main reference rates used in loans for the shipping industry is 3- and 6-month LIBOR (London Interbank Offered Rate). We would expect to see a significant increase in the cost of borrowing money on a short-term basis. As a result, credit conditions are expected to further tighten, increasing breakeven rates on assets. We would anticipate new investments into modern tankers to be few and far between without a corresponding adjustment to the value of the asset. A US default is not currently our base case scenario; however we do expect market volatility in the coming weeks while the two parties attempt to forge an agreement and authorize payment on the debt.
Figure 2: 3-Month and 6-Month LIBOR
Source: Marketwatch
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