Economists at UBS, led by Chief US Economist Jonathan Pingle, have also explored potential market reactions to a breach of the X-date. Notably, the US Dollar (USD), Japanese Yen (JPY), and Gold emerge as key assets that could be significantly influenced.
In most scenarios, Pingle anticipates a softening of the US Dollar amidst rising uncertainty. Interestingly, the only scenario where the US Dollar might rally strongly would involve a month-long impasse after the X-date. This extended deadlock could cause a significant tightening of financing conditions, boosting the USD in the process.
"Only a 1m long impasse post the X-date is likely to cause a tightening of financing conditions sharp enough that it causes the dollar to rally strongly." says Pingle.
In contrast, he suggests the worst-case scenario for the dollar arises if the X-date is crossed without any default. The fear of de-dollarisation, the process where the dominance of USD in the global financial system is gradually reduced, becomes a tangible threat in this case. "The worst case for the dollar is if the X-date is crossed without default; de-dollarisation becomes a real threat in this case." he adds.
Pingle believes that, from a risk hedging perspective, long positions in Japanese Yen against currencies such as the Australian Dollar (AUD) and Canadian Dollar (CAD) as well as calls on Gold might be the cleanest strategies in the event of a US default.
"JPY longs against AUD and CAD and Gold calls are the cleanest ways to hedge against a US default." says Pingle.
He further suggests that Gold could fare well across all levels of uncertainty and potential default scenarios. "We see Gold doing well through all levels of uncertainty and default." he adds.
In essence, these projections underscore the importance of being prepared for a range of outcomes, as the implications of the current debt ceiling impasse could be far-reaching and diverse across the financial landscape.
Debt Ceiling Conundrum: Economists at UBS Unveil Four Possible Scenarios
Economists at UBS suggest that there are four potential scenarios that may unfold due to the current impasse over the US debt ceiling.
The scenarios, laid out by Jonathan Pingle, Chief US Economist at UBS, range from the most optimistic - in which the debt ceiling is lifted with minor volatility - to the most pessimistic, where a month-long impasse creates significant economic strain.
Scenario 1: The Debt Ceiling is Lifted Amid Market Noise
The first scenario that Pingle describes involves the debt ceiling being raised ahead of any missed payments, causing some market turbulence but averting significant damage. This echoes previous political disagreements in 2011 and 2013, where market volatility was relatively short-lived, lasting no more than a few weeks.
"The economic impact under this scenario depends almost entirely on the level and duration of disruption that increased uncertainty might create for financial markets." says Pingle.
He adds, "We assume in this scenario that any financial volatility would be short-lived, lasting no more than a few weeks."
Scenario 2: The Debt Ceiling is Breached but Debt Payments are Prioritised
The second scenario involves the Treasury surpassing the so-called X-date but continuing to honour debt service payments. This could result in a significant retrenchment in federal spending as revenues cover only around 75% of non-interest expenditures.
"In this scenario, the Treasury goes past the X-date but debt service payments continue to be made." says Pingle.
However, he warns that this scenario could have a more detrimental effect on the economy. "The economic outlook is a little weaker... The Federal Reserve likely sees profound institutional risk being thrust into this political fight over fiscal policy." he adds.
Scenario 3: Principal and Interest Payments are Delayed after Breaching the X-date
The third scenario Pingle presents assumes that the US misses interest payments by more than a three-day grace period, leading to a formal default and probable downgrades.
"In this scenario, interest payments are missed and we've assumed by more than the 3- day grace period (i.e. a week) so that we can model a formal default and downgrades that would likely come with that default." says the analyst.
He continues, "In this scenario the US faces more serious downgrade risk, CDS default triggers, and downgrades to the GSEs." This, according to Pingle, could potentially lead to immediate consequences for the global financial system, given the USD and US Treasury Securities' status as the world's main reserve currency and 'safe' asset, respectively.
Scenario 4: A Prolonged, Month-long Standoff
The final scenario, which Pingle describes as highly unlikely, would see a month-long impasse in the US political system over the debt ceiling issue. This scenario, according to the analyst, could have the most significant impact on the economy, potentially doubling the severity of the recession in the US and leading to an estimated job loss of around 700,000.
"We give such an outcome very low odds... In this scenario, we could debate the path, but a large negative shock to growth at the current juncture we would argue sends the target range for the federal funds rate back to the zero lower bound." says Pingle.
"Depending on the speed of the market moves and if things become disorderly, we would expect the FOMC to 50 bp rate cuts in the next two meetings to see if that helped mitigate market disruption." he adds.
In most scenarios, Pingle anticipates a softening of the US Dollar amidst rising uncertainty. Interestingly, the only scenario where the US Dollar might rally strongly would involve a month-long impasse after the X-date. This extended deadlock could cause a significant tightening of financing conditions, boosting the USD in the process.
"Only a 1m long impasse post the X-date is likely to cause a tightening of financing conditions sharp enough that it causes the dollar to rally strongly." says Pingle.
In contrast, he suggests the worst-case scenario for the dollar arises if the X-date is crossed without any default. The fear of de-dollarisation, the process where the dominance of USD in the global financial system is gradually reduced, becomes a tangible threat in this case. "The worst case for the dollar is if the X-date is crossed without default; de-dollarisation becomes a real threat in this case." he adds.
Pingle believes that, from a risk hedging perspective, long positions in Japanese Yen against currencies such as the Australian Dollar (AUD) and Canadian Dollar (CAD) as well as calls on Gold might be the cleanest strategies in the event of a US default.
"JPY longs against AUD and CAD and Gold calls are the cleanest ways to hedge against a US default." says Pingle.
He further suggests that Gold could fare well across all levels of uncertainty and potential default scenarios. "We see Gold doing well through all levels of uncertainty and default." he adds.
In essence, these projections underscore the importance of being prepared for a range of outcomes, as the implications of the current debt ceiling impasse could be far-reaching and diverse across the financial landscape.
Debt Ceiling Conundrum: Economists at UBS Unveil Four Possible Scenarios
Economists at UBS suggest that there are four potential scenarios that may unfold due to the current impasse over the US debt ceiling.
The scenarios, laid out by Jonathan Pingle, Chief US Economist at UBS, range from the most optimistic - in which the debt ceiling is lifted with minor volatility - to the most pessimistic, where a month-long impasse creates significant economic strain.
Scenario 1: The Debt Ceiling is Lifted Amid Market Noise
The first scenario that Pingle describes involves the debt ceiling being raised ahead of any missed payments, causing some market turbulence but averting significant damage. This echoes previous political disagreements in 2011 and 2013, where market volatility was relatively short-lived, lasting no more than a few weeks.
"The economic impact under this scenario depends almost entirely on the level and duration of disruption that increased uncertainty might create for financial markets." says Pingle.
He adds, "We assume in this scenario that any financial volatility would be short-lived, lasting no more than a few weeks."
Scenario 2: The Debt Ceiling is Breached but Debt Payments are Prioritised
The second scenario involves the Treasury surpassing the so-called X-date but continuing to honour debt service payments. This could result in a significant retrenchment in federal spending as revenues cover only around 75% of non-interest expenditures.
"In this scenario, the Treasury goes past the X-date but debt service payments continue to be made." says Pingle.
However, he warns that this scenario could have a more detrimental effect on the economy. "The economic outlook is a little weaker... The Federal Reserve likely sees profound institutional risk being thrust into this political fight over fiscal policy." he adds.
Scenario 3: Principal and Interest Payments are Delayed after Breaching the X-date
The third scenario Pingle presents assumes that the US misses interest payments by more than a three-day grace period, leading to a formal default and probable downgrades.
"In this scenario, interest payments are missed and we've assumed by more than the 3- day grace period (i.e. a week) so that we can model a formal default and downgrades that would likely come with that default." says the analyst.
He continues, "In this scenario the US faces more serious downgrade risk, CDS default triggers, and downgrades to the GSEs." This, according to Pingle, could potentially lead to immediate consequences for the global financial system, given the USD and US Treasury Securities' status as the world's main reserve currency and 'safe' asset, respectively.
Scenario 4: A Prolonged, Month-long Standoff
The final scenario, which Pingle describes as highly unlikely, would see a month-long impasse in the US political system over the debt ceiling issue. This scenario, according to the analyst, could have the most significant impact on the economy, potentially doubling the severity of the recession in the US and leading to an estimated job loss of around 700,000.
"We give such an outcome very low odds... In this scenario, we could debate the path, but a large negative shock to growth at the current juncture we would argue sends the target range for the federal funds rate back to the zero lower bound." says Pingle.
"Depending on the speed of the market moves and if things become disorderly, we would expect the FOMC to 50 bp rate cuts in the next two meetings to see if that helped mitigate market disruption." he adds.