US Debt: What Happens if a Default Occurs?

Experts are discussing the ongoing negotiations between Republicans and Democrats in the US regarding the debt ceiling. While President Joe Biden is pushing for a resolution to the problem, some specialists are analyzing the possibilities of a default and the potential consequences it could have on the market.

One of those specialists is Chris Iggo, the CIO of AXA Investment Managers and Chairman of the AXA IM Investment Institute. He believes that if there is a debt crisis leading to a US debt default, it would be a great opportunity for many to buy. However, a US debt default would be a huge shock to the global financial system, leading to increased volatility, a weakened dollar, a disappearance of liquidity in the money market, and a stock market crash.

Iggo explains that trust in the US government has been one of the pillars of trust in global financial markets. If there is a default, this trust may be undermined for a long time. The consequences will also be global, both for bond yields and the dollar.

In the worst case, a debt default could lead to a slowdown in real growth due to the shock of aggregate demand caused by the reduction of government spending, private sector investments, and consumption. Negative consequences for prosperity are also possible if there is a correction in the stock market amid the chaos caused by default.

It is also necessary to consider the reaction of the Fed. More liquidity will undoubtedly be required, and the central bank may be forced to lower rates in response to increased market volatility and deteriorating growth prospects. Risk aversion would lead to a decline in the yield of long-term bonds, as the recession would become more likely and would occur earlier than in other scenarios.