Fed official warns of ‘extreme’ market reaction unless debt ceiling is raised

US Policy and Policy Updates

Two senior Federal Reserve officials warned Monday that failing to raise the US debt ceiling would have catastrophic consequences, as Republicans in the Senate blocked a bill to increase the borrowing cap and prevent a government shutdown.

John Williams, president of the Federal Reserve Bank of New York, said the US central bank could not mitigate the impact of a possible default on government debt. The Bipartisan Policy Center, a Washington think tank, estimated last week that the US government could default on its obligations by mid-October if the debt ceiling was not raised.

Williams warned reporters about the risk of investors becoming “extremely nervous” and thinking “I have to get out of things,” which he said could provoke an “extreme reaction in the markets.”

He said the prices of US Treasuries reflected the belief among investors that “cooler heads” would prevail in Congress and therefore were not necessarily an “indicator of how great the risks are.”

“If you really do cross that line and get to a place where the government is not paying its obligations, I think it would create a very negative dynamic not just in the US but around the world,” Williams said, invoking the collapse in the US Treasury bond market last year.

“We saw it in March 2020, the Treasury market. . . it is the center of the global financial system and if it cannot function it has repercussions ”, he said.

Trading conditions in the $ 22 trillion market for U.S. government debt were seized at the start of the pandemic last year as investors ditched even the safest securities in a broad-based race for cash. . The sudden outbreak of illiquidity forced immediate Fed interventions to avoid a more serious crisis.

Williams’ comments were echoed by Treasury Secretary Janet Yellen. In testimony to be delivered to the Senate banking committee on Tuesday, he implored lawmakers to raise the debt limit to avoid what he said would be a “catastrophic event for [the] economy”.

Federal Reserve Governor Lael Brainard on Monday also urged lawmakers to act on Monday. “Congress knows what to do. . . You need to intensify; it has responsibilities, ”he said.

Brainard and Williams’ comments follow Fed Chairman Jay Powell’s warnings last week of “severe damage” should the United States fail to meet its obligations.

The Democratic-controlled House of Representatives passed a measure this month in a party line vote to avoid a government shutdown on October 1 and extend the US debt limit until December of next year.

But the bill failed to clear the Senate’s 60-vote obstruction threshold Monday night, and Republicans in the upper house of Congress voted to reject the measure. Democrats, who control the Senate by the tiniest of margins, are now under pressure to raise the borrowing limit on their own and avoid a government shutdown before the 12:01 a.m. deadline on Friday.

Monday’s vote came after a weeks-long clash between Democrats, who wanted the Republican Party to sign to lift the Treasury borrowing limit, and Republicans, who steadfastly refused to back the measure and accused Joe’s party Biden of reckless spending.

Republicans voted to suspend the debt limit three times during the Donald Trump administration, with the backing of Democrats.

Mitch McConnell, the top Senate Republican, said before Monday’s vote that he and his fellow Republicans would back “clean” legislation that would fund the federal government to avoid a shutdown, but would not sign off on efforts by Democrats to bind the government. financing up to the debt ceiling.

“There is no chance that Republicans will help lift the Democrats’ credit limit so they can immediately smash through a socialist binge that will hurt families and help China,” McConnell said.

Democratic lawmakers are also struggling to resolve internal party divisions to pass Biden’s $ 1.2 Billion Flagship Infrastructure Bill and a $ 3.5 trillion social investment package in the coming weeks.

Nancy Pelosi, the Democratic Speaker of the House, has scheduled a decisive vote on the infrastructure bill for Thursday.

Pelosi said over the weekend that she would not bring the infrastructure bill to the House floor until she was sure she had the votes to pass it. That outlook still seemed uncertain on Monday, as several progressive and moderate lawmakers raised issues with the legislative package.

Progressives want assurances that the $ 3.5 trillion bill will not be diluted in the Senate, while moderates say radical social investments must be curtailed.

Biden adopted an optimistic tone at the White House on Monday, telling reporters: “I think things are going to go well, I think we are going to make it.” When asked what was “at stake” for his presidency amid disputes in Congress this week, the president responded, “Victory is at stake.”

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