Progress made in US debt talks but risk of default continues

There has been “some progress” on negotiations to raise the so-called debt limit of the US, speaker of the House of Representatives Kevin McCarthy said on Thursday, with barely a week to go until the country effectively runs out of money to pay its bills. Still, the brinkmanship continues as politicians in Washington play a game of chicken over the debt limit which could have huge implications both for the US and much of the global economy.

“We worked well past midnight last night,” McCarthy told reporters. “There’s still some outstanding issues and I’ve directed our teams to work 24/7 to try to solve this problem.”

The US government needs to borrow more to pay its bills but in return Republicans, who control the House of Representatives, want to see cuts in overall government spending and tighter work requirements for those who benefit from some social programmes. The Biden administration wants taxes and other revenue-generating measures to form part of an overall deal.

Treasury secretary Janet Yellen said on Monday that it was “highly likely” that the federal government would no longer be able to pay all its bills by early June “and potentially as early as June 1st″ if Congress did not either raise or suspend the current debt ceiling.

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Hardline Republicans are sceptical about the June 1st deadline and some on Wall Street believe that perhaps the US Treasury could get by for a few more days. But most believe the cliff edge – or the “X date, as it is known – is drawing near.

The White House has argued that even getting close to a debt default would cause huge disruption.

The yield, or interest rate, on short term US bonds, known as treasury bills, due to be repaid in early June increased on Thursday morning. That may be an indication that traders are beginning to price in the possibility of a default that has long been unthinkable.

Yellen has said if the debt ceiling was not raised “hard choices” would have to be made about which bills went unpaid.

Some Republicans have suggested legislation to force the US Treasury to give priority to certain payments such as to bondholders or those receiving social security. However in January Yellen argued that “a failure on the part of the United States to meet any obligation, whether it’s to debtholders, to members of our military or to social security recipients, is effectively a default”.

The White House said its council of economic advisers (CEA) had warned that an actual breach of the debt ceiling would likely cause severe damage to the US economy. “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,” it said.

On Wednesday ratings agency Fitch put the United States’ current AAA credit on watch for a possible downgrade, which would impact the pricing of trillions of dollars of US debt.

In 2011 during a previous row over the debt limit S&P downgraded the United States to AA-plus and set off a cascade of other downgrades as well as a stock market sell-off of close to 20 per cent.

Moody’s Analytics said in an assessment this month that Moody’s Investors Service had maintained it would downgrade if the US Treasury failed to make a bond payment. If such an event was short-lived the ratings impact “would likely be limited”, it added.

Moody’s Analytics argued that a short-term default could see the US economy lose 1.5 million jobs. It said while there may be little long-term fallout on the economy, global investors could demand several basis points more in interest on Treasury debt to compensate for the meaningful risk that the debt limit could be breached again in the future.

The White House said the council of economic advisers warned a protracted default could “lead to immediate, sharp recession on the order of the Great Recession” of 2007 to 2009.