Split U.S. Congressional midterm election result could loom another debt ceiling battle in financial markets

Several Republican lawmakers have already signaled that they will use the debt ceiling negotiations as leverage to push for deep cuts in US government spending, potentially in Social Security or Medicare. But Biden, a Democrat, has already ruled out spending cuts for either program.

This sets the stage for a prolonged and bitter confrontation. All it takes is a small cohort of Republican lawmakers to hold their ground, and the United States could be pushed to the brink of default.

Significant budget deficits

The US debt ceiling needs to be raised because the government continues to spend far more money than it collects in tax revenue, meaning it runs large budget deficits. The US Congressional Budget Office estimates that Washington will run annual deficits averaging US$1.6 trillion over the next decade.

To finance these budget deficits, the US Treasury must borrow money. But when it exhausts its power to borrow more money, the US Congress must approve an increase in the debt ceiling.

A failure to lift the debt ceiling could force the U.S. Treasury not to pay bondholders or to prioritize its spending obligations in a way that could disrupt basic U.S. government services and Social Security payments. .

The threat of the US government defaulting on its debts would be a catastrophic blow to confidence in global bond markets and push US borrowing costs higher.

Already, the yield on benchmark US 10-year bonds has more than doubled this year – from 1.71% in early January to 3.89% – as investors worried about rising inflation. (Yields rise as bond prices fall).

A further rise in US long-term interest rates would add to the slowdown in US economic growth.

Moreover, instability in the world’s largest bond market would also ripple through global financial markets, driving up borrowing costs and putting pressure on the price of riskier assets, such as stocks and real estate. .

Some analysts point out that the US government does not need to default on its debt for there to be negative consequences. A similar crisis occurred in 2011 when a Republican Congress tried to force Democratic President Barack Obama to agree to deep cuts in exchange for an increase in the borrowing limit.

The impasse took so long to resolve that Standard & Poor’s finally downgraded the United States’ credit rating for the first time, sending financial markets into a tailspin.

Although Democratic congressional leaders have pledged to lift the debt ceiling while they still control both chambers, it’s unclear whether they have enough time to push the legislation through before the start of the newly elected Congress. early January.

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