Janet Yellen says there could be a financial crisis if there's no deal on the debt ceiling by August. 5 experts break down what's at stakeand whether markets will face 'catastrophic' consequences

<p><img src="https://static1.businessinsider.com/image/60dc60672cb2e800110ddb85-525-393/GettyImages-495620136.jpg" border="0" alt="Janet Yellen testifies before the House Finance Committee" width="525" height="393" data-mce-source="Chip Somodevilla/Getty Images" data-mce-caption="Janet Yellen testifies before the House Finance Committee" data-link="https://www.gettyimages.co.uk/detail/news-photo/federal-reserve-chair-janet-yellen-testifies-before-the-news-photo/495620136"></p><p></p><bi-shortcode id="summary-shortcode" data-type="summary-shortcode" class="mceNonEditable" contenteditable="false">Summary List Placement</bi-shortcode><p>Treasury Secretary Janet Yellen has issued an <a href="https://news.bloombergtax.com/daily-tax-report/yellen-renews-plea-to-raise-debt-limit-ahead-of-july-31-deadline">ominous warning</a> to lawmakers about the potential fallout from not ensuring the US government's ability to keep on borrowing.&nbsp;</p><p>She told a Senate panel on June 23 the US may not be able to pay its bills by mid-August and could be at risk of default unless the debt ceiling is raised or resuspended before the annual recess for Congress in August.</p><p>The debt ceiling is the maximum amount the US government can borrow to meet its financial obligations. Congress agrees on what that amount is. Once that limit is reached,&nbsp;the Treasury cannot issue more bills, notes or bonds and must resort to extraordinary measures. This limit has been frozen from 2019 to July 31, 2021.&nbsp;</p><p>"Failing to increase the debt limit would have absolutely catastrophic economic consequences," Yellen said. "I believe it would precipitate a financial crisis. It would threaten the jobs and savings of Americans at a time when we're still recovering from the Covid pandemic."</p><p>Insider spoke to strategists, economists and fixed income investors to understand how likely it is this event will occur and the impact on markets.</p><h2>What if there's no deal'</h2><p>None of the five experts believe there will be any kind of deal on the ceiling by the end of July.</p><p>Adjusting the debt limit is considered a "must-pass" issue and is often used as leverage for other pieces of legislation, Nancy Vanden Houten, lead economist at <a href="https://www.oxfordeconomics.com/">Oxford Economics</a>, said in an email.</p><p>"The most likely scenario is that the debt limit will be raised as part of a budget reconciliation measure that Congress isn't expected to pass until sometime in the fall," Houten said.</p><p>Democrats considered including the ceiling increase in President Joe Biden's $1.9 trillion coronavirus relief package, which passed in March. This now looks like it will either be added to a subsequent package or involve negotiating with Republicans.</p><p>"There's a low probability that the debt ceiling will be resuspended before July 31," Barclays strategist Joseph Abate said. "I think a lot of it depends on the negotiations in Congress with respect to the infrastructure bill and whether they can get the bipartisan bill through the house and with enough votes in the Senate."</p><h2><strong>When will the Treasury exhaust extraordinary measures'</strong></h2><p>The US Treasury has used extraordinary measures, such as suspending different programs, in the past and Congress has always raised the debt ceiling before these are exhausted.&nbsp;</p><p>"Several analysts that I read think it is probably some timeframe in October," Jeff Hibbeler, a fixed income portfolio manager at <a href="https://exencialwealth.com/">Exencial Wealth Advisors,</a> said. "But it hinges on the legislative process and how much they want to tie it into various budgets, or other legislation that they're trying to pass."</p><p>All five experts believe the Treasury should be able to leverage extraordinary measures until the fall.</p><p>"We think that they probably have enough cash and borrowing authority to make it through September and into October," Abate said.</p><h2>So why the warning now'</h2><p>It's not uncommon for the Treasury Secretary to warn lawmakers, if nothing else but to prompt some action.</p><p>"Treasury secretaries don't want there to be any question that the US is going to honor debt obligations," Hibbeler said.</p><p>This is also a more unusual period, given the heavy amount of spending related to the pandemic, Oxford's Houten said.</p><p>"While Congress has always managed to raise or suspend the debt limit in time, that's still not a guarantee it will do so again, and the consequences of not doing so would be severe," she said.</p><h2>How will markets react'</h2><p>The market reaction will be muted even after July deadline passes, according to the experts.</p><p>Volatility will likely only pick up across the market as extraordinary measures are closer to being exhausted, with shorter-dated Treasuries seeing the biggest impact. Overall however, there's unlikely to be any dramatic moves in yields.</p><p>Some short-term investors might see the deadline as a good opportunity to scoop up Treasurys more cheaply, Dan Krieter, director of fixed income strategy at BMO Capital Markets, said.</p><p>When investors know the date when extraordinary measures could be exhausted then there could be a cheapening of Treasury bill yields, Barclays' Abate said.</p><p>Houten also expects financial markets to become more volatile around that time, especially if it still looks uncertain on when Congress will raise the ceiling.</p><p>"Stock prices could decline if risks of a recession rise, and bond investors could demand higher yields if they think there is a greater risk that Treasury won't meet its debt obligations," Houten said.</p><p>Even if raising the ceiling goes until the eleventh hour, it won't be a long or medium-term issue for markets, said David Roberts, who co-runs <a href="https://www.liontrust.co.uk/fund-teams/global-fixed-income-team">Liontrust's Global Fixed Income</a> portfolios.</p><p>But, at the same time, there is a lot of complacency built into the markets, with US equity indices consistently reaching all-time highs, he said.</p><p>"There's not really much in the price of any major market for turbulence, for rising volatility, for upset," Roberts said.</p><p>The last time this happened was in 2011 and it cost the US its triple-A debt rating, when ratings agency Standard &amp; Poor <a href="https://www.bbc.co.uk/news/world-us-canada-14428930">downgraded</a> US paper. However, Treasurys still boast one of the highest ratings in the world, which shows there is little doubt aover US creditworthiness at this point.&nbsp;</p><p>"I'd be surprised if it created a major ripple but it might be enough, if there are a few other things going on, at the same time, for people to question this wall of free money that we were still enjoying and then to question the valuation of markets built from that," Roberts said.</p><p><a href="https://www.businessinsider.com/market-crash-experts-outlook-janet-yellen-us-debt-limit-warning-2021-6#comments">Join the conversation about this story &#187;</a></p> <p>NOW WATCH: <a href="https://www.businessinsider.com/hm-zara-uniqlo-fast-fashion-spend-money-clothes-2019-1">Sneaky ways stores like H&M, Zara, and Uniqlo get you to spend more money on clothes</a></p>
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