How will a US debt default impact Brent in the near-term?
The White House has warned of a "severe recession" if the US defaults on debt and coupon payments. This will mount pressure on Brent prices, heavily influenced by fundamentals.
PHOTO: The White House in Washington DC, US. Getty Images
In a warning to President Joe Biden's administration, the US Secretary of the Treasury, Janet Yellen said America is fast approaching its debt ceiling "x-date" as it could run out of cash to pay its bills.
The White House’s Council of Economic Advisors (CEA) issued another dire warning - that the markets are “already pricing in political brinkmanship related to Federal government default through higher risk premia.”
What is the x-date?
The "x-date" refers to the date when the treasury department's "extraordinary measures" are exhausted, forcing the regime to default, assuming the federal borrowing limit is not raised.
"The X date is always uncertain due to the inexact nature of tax collections and certain government payments, and this year, with the tax collections around the April 15 payment deadline running well below last year’s levels, Treasury’s funding needs have risen," bond giant PIMCO's analysts wrote in a note to investors.
An unlikely event?
The US government has hit its debt ceiling a few times in the past, most notably in 2013 and 1995, though has never defaulted. Nevertheless, this time could be different, warned the CEA, since “the cost of insuring US debt has also risen substantially and is now at an all-time high, reflecting increased worries about a US default.”
“It is unlikely that the US Treasury would choose to default on its debt obligations, but it could in the extreme find itself having to do so should Congress fail to either suspend or raise the debt ceiling,” says Padhraic Garvey, ING’s head of regional markets – Americas.
PHOTO: An illustration of an oil barrel and pumping jack on US dollar bills. Getty Images
Adverse impact on Brent in the near-term
Historically speaking, Brent rates have been affected by the aftershocks of the US reaching its debt ceiling. In the five months leading up to the x-date in 2013, Brent lost $13/bbl. Prices collapsed by $13/bbl after the US met its debt ceiling in May 2011, from $126/bbl in April to $113/bbl in June.
However, this year may be different since the nation's economy is already strained. Banking turmoil and high-interest rates are already taking their toll. And another blow in the form of a default would virtually cripple the world’s largest economy, according to the CEA.
Oil traders are presumably concerned about what will happen after the default. CEA simulations predict an "immediate, sharp recession on the order of the Great Recession" if the US defaults.
The CEA's worst-case scenario pegs a 5% rise in unemployment and "substantial hits" to consumer and business confidence. “Unlike the Great Recession and the COVID recession, the government is unable to help consumers and businesses. As the breach continues, the economy heals slowly, and unemployment is still 3 percentage points higher at the end of 2023.”
In the near-term, a severe recession in the US could prove catastrophic for Brent prices, which are already vulnerable to demand jitters in China and slowing growth in Europe.
It is expected that Brent will remain under pressure until the debt ceiling issue is resolved, given the high level of macroeconomic uncertainty right now, oil analyst and co-founder of Energy Aspects, Amrita Sen told CNBC. The oil market is pricing in a very deep recession in the US that could push Brent to levels close to $60/bbl in the near term, she added.
By Konica Bhatt
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