NEW YORK - A debt ceiling fight is looming in the United States yet again, giving investors another worry for markets this year.

The US hit its mandated US$31.4 trillion (S$41.5 trillion) borrowing limit on Thursday, forcing the Treasury to launch extraordinary cash management measures to prevent a debt default until June.

Recurring legislative standoffs over the debt limits this last decade have largely been resolved before they could ripple out into markets. That has not always been the case, however: A protracted standoff in 2011 prompted Standard & Poor’s to downgrade the US credit rating for the first time, sending financial markets reeling.

Some investors worry that the Republican party’s narrow majority in Congress could make it harder to reach a compromise this time.

Here is a Q&A about the implications for markets:

What is the debt ceiling?

The debt ceiling is the maximum amount the US government can borrow to meet its financial obligations. When the ceiling is reached, the Treasury cannot issue any more bills, bonds or notes. It can only pay bills through tax revenues. The ceiling now is equal to roughly 120 per cent of the US’ annual economic output.

When will the US exhaust its cash and borrowing capacity?

Treasury Secretary Janet Yellen last week said the government could pay its bills only through early June without raising the limit. That is sooner than some analysts’ forecasts that the government would exhaust its cash and borrowing capacity – the “X Date” – some time in the third or fourth quarter.

Mr Jonathan Cohn, head of rates trading strategy at Credit Suisse in New York, estimated the “drop-dead date” between September and early November. Goldman Sachs estimated the debt ceiling would be reached between August and October.

What can the Treasury do to meet its obligations?

It can use cash on hand and extraordinary measures to generate cash once the debt limit is reached. It had a closing balance of US$321.5 billion in the Treasury General Account (TGA) as at Jan 13. The Treasury on Thursday began a “debt issuance suspension period” to last through June 5 that suspends investments in the Civil Service Retirement and Disability Fund which are not immediately required to pay beneficiaries, Dr Yellen said.

Do bond prices reflect US default risks?

Some Treasury bills maturing in the second half of 2023 already feature a premium in their yields that may be tied to an elevated default risk during that window, according to some analysts.

Meanwhile, the cost of insuring US debt against default for five years stood at about 32 basis points on Tuesday, the widest spread since 2013.

“The Treasury curve is pricing in some kind of distortion in the Q3-Q4 time period... consistent with the exhaustion of stop-gap measures that the government can use now to run down cash balances at the Treasury in order to fund the government,” said Mr Eric Theoret, global macro strategist at Manulife Investment Management.

For Mr Andrew Hunter, senior US economist at Capital Economics, yields of Treasury bills and bonds due this summer may rise in the coming months as the risk of a crisis rises.

What happens if the US defaults?

The rising risk of a default could push some investors to move money into global equities and foreign governments’ bonds.

In 2011, political gridlock in Washington over the debt ceiling sparked a stocks sell-off and took the US to the brink of default, with the country losing its top-tier AAA credit rating from Standard & Poor’s.

Goldman Sachs in a research note said the S&P 500 fell 15 per cent during the 2011 crisis with stocks with the greatest sales exposure to US federal spending plunging by 25 per cent.

In 2021, some equity weakness and anomalies in the pricing of short-term Treasury bills showed rising concerns as Congress faced approaching deadlines to fund the government and address the debt ceiling.

An actual US debt default would likely send shockwaves through global financial markets, as investors would lose confidence in the US ability to pay its bonds, which are seen as among the safest investments and serve as building blocks for the world’s financial system.

That “could leave some lasting scars, including a permanent increase in the cost of funding US federal debt”, said Mr David Kelly, chief global strategist at JP Morgan Asset Management. REUTERS