US default scenarios span from localised pain to Jamie Dimon's 'panic'

Christopher Anstey & Liz Capo McCormick

Investment bank clients are peppering Wall Street with questions about what happens if the US Treasury in coming weeks runs out of cash and does the unthinkable — failing to make payments due on Treasury securities, the bedrock of the global financial system.

Market participants have long assumed that, if the Treasury ran out of sufficient cash during a partisan debt-limit showdown, it would prioritize interest and principal payments on publicly held Treasuries. That $24 trillion market serves as a global benchmark for borrowing costs, serves as vital collateral for funding in money markets and forms a core part of asset holdings the world over.

The assumption has never been tested, however, and Treasury officials have long cast doubt in public about whether prioritisation is practicable. So given the intensity of the current showdown, market participants are gaming out scenarios.

One school of thought is that the impact might not be so damaging. After all, since the 2011 debt-limit crisis, market participants have worked out a process for dealing with the Treasury announcing that it couldn’t make an interest or principal payment.

But JPMorgan Chase & Co Chief Executive Officer Jamie Dimon warned earlier this month that even going to the brink is dangerous, with unpredictable consequences. 

“The closer you get to it, you will have panic,” he told Bloomberg Television. “The other thing about markets is that, always remember, panic is the one thing that scares people — they take irrational decisions.”

And even a key group that helped to compile the emergency procedures, the Federal Reserve Bank of New York-sponsored Treasury Market Practices Group, has issued its own caution. 

Broader disruption in financial markets would quickly put focus on the Fed, which during the 2011 debt-limit showdown compiled a backstop menu of options to avert systemic collapse. When reviewing those in 2013, then-board member Jerome Powell referred to two of them as “loathsome” — while stopping short of saying that he’d reject them.

Powell has repeatedly delivered the message that “no one should assume that the Fed can protect the economy” if Congress doesn’t address the debt limit.  
 

‘Localised’ impact

“We are likely to see localised dislocations in the event of missed payment,” if that were to happen, JPMorgan rates strategists, co-led by Jay Barry, wrote on Friday in a Q&A.

RBC Capital Markets strategists, also writing Friday, said they “doubt” a downgrade would trigger any forced reallocation by fund managers away from Treasuries. At the same time, RBC’s Blake Gwinn and Izaac Brook cautioned that the “back-office issues” of delaying payments “could very easily bleed into the front-office, causing disruptions to liquidity and market functioning”.