Broker Check

What will happen with the debt ceiling and stock market?

| May 12, 2023

The answer depends on the outcome of the debt ceiling standoff between President Biden and the Republican leaders. There are four possible scenarios¹:

- A temporary debt ceiling suspension until September. This is the most likely and favorable outcome for the economy and the stock market, according to Ned Davis Research¹. It would avoid a default and give more time for negotiations.
- A debt ceiling increase with spending cuts and other conditions. This is the preferred option for the Republicans, but it would face strong opposition from the Democrats. It could also hurt the economy by reducing fiscal stimulus and increasing uncertainty.
- A debt ceiling increase with reconciliation. This is the fallback option for the Democrats, but it would require them to use their limited reconciliation process to pass a budget resolution that includes a debt ceiling increase. It could also face delays and complications from moderate Democrats who may not support some of the spending proposals.
- A debt default. This is the worst-case scenario and the least likely one, according to most analysts. It could cause an economic catastrophe, as determined by Treasury Secretary Janet Yellen (who potentially is conflicted being a political appointee but also has credibility being a former Fed Chair)²³. It could wipe out about 8.3 million jobs and bring unemployment 5 percentage points higher, according to White House economists⁶. It could also cut the stock market in half and spike interest rates, according to JPMorgan Chase CEO Jamie Dimon⁵.

The stock market could react very differently depending on how the debt ceiling issue is resolved. Right now, Wall Street is strangely calm about the possibility of a default, but that could change this month if there is no major movement in Congress⁴.

My feeling is since the market has seen this before it will not react strongly unless we see something close to or worst then the events of 2011.  A contingent of Republicans did hold up Speaker McCarthy's Speakership vote so the sense is the same caucus could also complicate matters over the debt ceiling and cause a crisis.      

Using history as a guide, in 2011 during the last debt ceiling standoff, the stock market declined by about 19% but soon recovered after it was resolved.  In fact the stock market went on to make new all time highs and see significant growth the next few years.

(1) Here's how the economy and the stock market could react to the 4 possible outcomes of the debt ceiling standoff.
(2) 'This is not a game,' BU economist explains why raising debt ceiling is so crucial.
(3) ‘Every family should be concerned’ about debt ceiling, consumer watchdog warns.
(4) White House warns debt default could wipe out 8 million jobs ... - CNN.
(5) Jamie Dimon Says a US Debt Default Is 'Potentially Catastrophic'.
(6) Premarket stocks: Wall Street is strangely calm about the debt ceiling ....