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The White House has warned stocks will plunge 45% and a deep recession will strike in the 3rd quarter if the US defaults
22 May 2023
A US debt default could spark a 45% crash in the stock market and generate a deep recession akin to the 2008 Great Financial Crisis, the White House's Council of Economic Advisers warned earlier this month.
The deadline for lawmakers to lift the debt limit is rapidly approaching in early June as Treasury Secretary Janet Yellen exhausts all of the department's extraordinary measures. If a debt ceiling deal isn't reached, it could mean the Treasury forgoes Social Security payments, payments to Medicare and Medicaid, and ultimately payments to US bond holders.
A potential debt default in mid-June has led to a surge in the US 1-month Treasury yield to 5.56% from its low of 3.31% last month.
"The closer the US gets to the debt ceiling, the more we expect these market-stress indicators to worsen, leading to increased volatility in equity and corporate bond markets and inhibiting firms' ability to finance themselves and engage in the productive investment that is essential for extending the current [economic] expansion," The White House CEA said in a May 3 post.
But other market measures show little chances of a US debt default happening, with the stock market's VIX fear gauge trading at low levels and the broader stock market trading near one-year highs. Meanwhile, credit default swaps current imply just a 4% chance of a US debt default, according to JPMorgan.
If the US does see a protracted debt default, in which a default is not quickly rectified after it happens, the White House warned the stock market could plunge 45%, which would send the S&P 500 to 2,250 based on where the index traded on May 3.
Additionally, millions of people would lose their jobs and a sharp economic contraction would lead to a massive recession, the CEA warned.
The projections are based on a simulation run by the White House of potential outcomes if the US defaulted on its debt for the first time in its 246-year history.
"In the third-quarter of 2023, the first full quarter of the simulated debt ceiling breach, the stock market plummets 45%, leading to a hit to retirement accounts; meanwhile, consumer and business confidence takes substantial hits, leading to a pullback in consumption and investment," the CEA said, adding that unemployment would increase by 5 percentage points.
To make matters worse, in a potential protracted default, the government would be unable to enact fiscal stimulus measures to help support the economy, like it did during the COVID-19 pandemic and in the aftermath of the 2008 Great Financial Crisis.
The CEA compared its work to a simulation by credit rating agency Moody's, which suggests a protracted default scenario would lead to almost 8 million job losses.
"Without the ability to spend on counter-cyclical measures such as extended unemployment insurance, Federal and state governments would be hamstrung in responding to this turmoil and unable to buffer households from the impacts," the CEA explained.
Additionally, US households would be unable to turn to the private sector for loans because interest rates for credit cards and personal loans would "skyrocket," the CEA said.
President Joe Biden and House Speaker Kevin McCarthy are scheduled to meet about the debt ceiling later today.
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