JULY 2011
THE NEWS IN PERSPECTIVE
US debt ceiling negotiations: Possible
outcomes and the implications of each
by Erik S. Weisman, Ph.D.
investors are focused on the ongoing US debt ceiling negotiations. US
M any
President Barack Obama and congressional leaders must meet an August 2
ERIK S.
WEISMAN, Ph.D.
FIXED-INCOME
PORTFOLIO
MANAGER
Erik S. Weisman is a portfolio manager
and sovereign fixed-income analyst at
MFS Investment Management®. He joined
the firm in 2002 and has 13 years of
industry experience.
deadline to raise the $14.29 trillion borrowing limit or face a possible default on US
sovereign debt. While Congress has agreed to vote on a bill in the upcoming days,
until the votes are cast and the bill passed, anything can happen. This News in
Perspective outlines the major options being considered and briefly highlights the
potential implications of each.
1. Short-term deal that necessitates another debt ceiling negotiation in a few
months: This would avert a short-term disaster, but uncertainty would remain.
Threats of downgrades or actual downgrades by credit rating agencies remain
likely. Not conducive to a return of risk-on sentiment.
2. Debt ceiling raised $1.0 trillion to $1.5 trillion: This would force another debt
ceiling negotiation in mid-2012, during the presidential election campaign. Better
than option #1, but not by much. Prospects of raising the debt ceiling during an
election cycle are not great. Threat of downgrades or actual downgrades by credit
rating agencies remains. Not particularly conducive to a return of risk-on
sentiment.
3. Debt ceiling raised $2.0 trillion to $2.5 trillion: This would push the next debt
ceiling discussion to early 2013, after the election, and might set the stage for the
“grand bargain.”1 Would kick the can sufficiently down the road such that the
near- and medium-term risk associated with the US public debt profile dissipates
and risk sentiment is again determined by macroeconomic fundamentals. Credit
rating agencies may provide some forbearance on downgrades until after the
elections when prospects for early 2013 grand bargain are more clear.
4 Debt ceiling raised $4.0 trillion: This would allow for a grand bargain
negotiation to stretch into 2014 if necessary. Better than option #3, especially if
there is greater movement on both entitlement reform and revenue enhancement.
Kicks the can sufficiently down the road such that the near- and medium-term
risk associated with the US public debt profile dissipates and risk sentiment is
again determined by macroeconomic fundamentals. Credit rating agencies are
likely to provide greater forbearance on downgrades until after the elections,
when prospects of 2013 grand bargain are clearer.
(continued on next page)
THE NEWS IN PERSPECTIVE
5. Senator McConnell-type deal:2 This proposal would
give the president the unilateral authority to raise the
debt ceiling in stages, which provides breathing space
until post-election 2013 and possible grand bargain.
This is weaker than option #3, as prospects for
spending cuts would likely be lower.
6. No deal by the deadline, but US honors debt
obligations: Risk off until debt ceiling is raised. Until
debt ceiling is raised, would be equivalent of
annualized 10% of gross domestic product (GDP) cut
in government spending. High likelihood of credit
rating downgrades with negative outlooks. Very
negative for economic activity, lower inflationary
expectations, likely negative for the US dollar, effect on
US Treasury yields ambiguous (higher risk of default
versus prospects for much lower nominal GDP).
Market turmoil and dislocation commensurate with
length of negotiations standoff and terms of eventual
debt ceiling agreement.
7. No deal by the deadline; United States defaults:
Potentially enormous risk off until debt ceiling is
raised. Until debt ceiling is raised, would be equivalent
of annualized 10% of GDP cut in government
spending. Definite rating downgrades (and possible
“default” designation) with negative outlooks. Very
negative for economic activity, lower inflationary
expectations, likely highly negative for the US dollar,
US Treasury yields likely higher. Market turmoil and
dislocation commensurate with length of negotiations
standoff and terms of eventual debt ceiling agreement.
But unless the eventual agreement is perceived as a
major step toward the ultimate grand bargain, the
genie will have been released from the bottle and US
creditworthiness would likely be damaged over the
long term.
1
“Grand bargain” refers to the tradeoff between significant cuts in entitlement programs in exchange for significant revenue raised through tax increases, both of which are necessary to return the United States to a sustainable public-sector debt path. To the extent that any size rise in the debt ceiling is not associated with meaningful spending cuts and/or
higher revenue, the credit rating agencies would view the outcome as less favorable to retaining “AAA” status.
2
US Senate Minority Leader Addison Mitchell “Mitch” McConnell, Jr., of Kentucky has proposed as a last resort to give the president unilateral power to raise the debt ceiling by $2.5
trillion in three stages by the end of 2012.
The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon
as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor.
Issued in the United States by MFS Institutional Advisors, Inc. (“MFSI”) and MFS Investment Management. Issued in Canada by MFS Institutional Advisors, Inc.
Issued in the United Kingdom by MFS International (U.K.) Limited (“MIL UK”) a private limited company registered in England and Wales with the company number
03062718, and authorised and regulated in the conduct of investment business by the UK Financial Services Authority. MIL UK, an indirect subsidiary of MFS, has its
registered office at Paternoster House, 65 St Paul’s Churchyard, London, EC4M 8AB and provides products and investment services to institutional investors globally.
Issued in Hong Kong by MFS International (Hong Kong) Ltd. This document has not been reviewed or approved by the Hong Kong Securities and Futures Commission.
Issued in Latin America by MFS International Ltd. For investors in Australia and New Zealand: MFSI is exempt from the requirement to hold an Australian financial
services license under the Act in respect of the financial services. MFSI is regulated by the SEC under US laws, which differ from Australian laws. In Australia and New
Zealand, please contact BNP Paribas Investment Partners (Australia) Limited ABN 78 008 576 449 AFSL 223418 for further information about MFS Investment
Management. BNP Paribas Investment Partners can be contacted at 60 Castlereagh Street SYDNEY NSW 2000, Tel: +61 (02) 9619 6291.
MFSE-NPDEBT-NL-7/11
22955.1