Oct 21, 2022 - Economy

Debt ceiling hijinks just got riskier

Illustration of a nervous-looking Ben Franklin on a twenty dollar bill looking up at a metal ceiling

Illustration: Sarah Grillo/Axios

The defenestration of U.K. Prime Minister Liz Truss suggests that the risks of an American debt-ceiling standoff could be higher than when such tactics were last deployed.

Why it matters: Midterm elections in the U.S. could put Republicans in control of the House of Representatives. This raises the specter of a replay of the debt-ceiling brinkmanship that broke out roughly a decade ago.

  • But as the Truss debacle shows, today's market conditions could make for a more explosive result.

Driving the news: Truss' resignation Thursday came just weeks after her first fiscal plan provoked violent swings in the prices of British bonds and the pound.

Context: The Truss government badly misjudged the market backdrop, against which it unveiled plans for larger-than-expected tax cuts, which implied larger budget deficits to come.

  • For much of the last two decades, super-low inflation and the calming influence of central bank bond-buying programs kept markets relatively sedate, despite growing budget deficits.

Yes, but: Inflation has changed all that. Instead of buying bonds to keep rates low, central banks are reducing their holdings to push rates higher. That leaves market players on the hook to buy billions of dollars of additional government debt each month. If they're reluctant to do so, it results in higher yields and more violent market moves.

Meanwhile: Republicans look poised to retake control of the House of Representatives in midterm elections next month — and with it the budgetary reins of the Federal government.

Flashback: After taking control of the House in 2010, Republicans used similar tactics, resulting in a series of budget standoffs.

Our thought bubble: In isolation, the damage from those debt-ceiling fights looks limited.

  • But remember, back in 2011, the Fed had interest rates pinned at almost zero.
  • The Fed was not dumping almost $100 billion of bonds on the market each month.
  • Inflation was nowhere near its current level of more than 8% annually.

The bottom line: Nobody knows what the real risks embedded in the bond market are right now — not even the Fed, whose officials were nervously asking around about it, per a New York Times report. A messy debt ceiling fight, or, outlandish as it may sound, a full-on default, would almost certainly reveal them.

  • And as Truss found out, the process could be unpleasant for politicians.

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