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

A top Federal Reserve official warned that failing to raise the US debt ceiling would have grave consequences as Republicans in the Senate blocked a bill to increase the borrowing limit and stave off a government shutdown.

John Williams, the president of the Federal Reserve Bank of New York, said on Monday that the US central bank would be unable to mitigate the impact of a potential default on the government’s debt.

Williams warned of the risk that investors could become “extremely nervous” and think “I’ve got to get out of things”, which he said could lead to an “extreme kind of reaction in markets”.

His comments were echoed by Treasury secretary Janet Yellen. In prepared testimony due to be delivered to the Senate banking committee on Tuesday, she implored lawmakers to raise the debt limit in order to avert what she said would be a “catastrophic event for [the] economy”.

The Bipartisan Policy Center, a Washington think-tank, estimated last week that the US government could default on its obligations as soon as mid-October if the debt ceiling were not raised.

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

“If you actually crossed that line and got to a place where the government wasn’t paying off its obligations, I think it would create a very negative dynamic not only in the US but around the world,” Williams said, invoking the meltdown in the market for US Treasuries last year.

Trading conditions in the $22tn market for US government debt seized up at the onset of the pandemic last year, as investors ditched even the safest securities in a broad-based dash for cash. The abrupt bout of illiquidity forced immediate interventions from the Fed to stave off a more severe crisis.

Federal Reserve governor Lael Brainard on Monday also urged lawmakers on Monday to act. “Congress knows what it needs to do . . . It needs to step up; it has responsibilities,” she said.

The comments from Brainard and Williams follow warnings from Fed chair Jay Powell last week of “severe damage” should the US default on its obligations.

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

But the bill failed to clear the Senate’s 60-vote filibuster threshold on Monday evening, with Republicans in the upper chamber of Congress voting to reject the measure. Democrats, who control the Senate by the slimmest of margins, are now under pressure to raise the borrowing limit on their own and avert a government shutdown ahead of a 12:01am Friday deadline.

Monday’s vote came after a weeks-long stand-off between Democrats — who wanted the GOP to sign on to lifting the Treasury’s borrowing limit — and Republicans, who steadfastly refused to endorse the measure and accused President Joe Biden’s party of reckless public spending.

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

Mitch McConnell, the Senate’s top Republican, said ahead of Monday’s vote that he and his GOP colleagues would back a “clean” piece of legislation that funded the federal government to avoid a shutdown but would not sign on to the Democrats’ efforts to tie government funding to the debt ceiling.

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

Democratic lawmakers are also hurrying to solve internal party divisions in order to pass Biden’s flagship $1.2tn infrastructure bill and a $3.5tn social investment package in the coming weeks.

Nancy Pelosi, the Democratic Speaker of the House, has scheduled a make-or-break vote on the infrastructure bill for Thursday.

Pelosi said at 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 prospect still looked uncertain on Monday, as several progressive and moderate lawmakers raised issues with the legislative package.

Progressives want assurances that the $3.5tn bill will not be watered down in the Senate, while moderates say the sweeping social investments need to be scaled back.

Biden struck an upbeat tone at the White House on Monday, telling reporters: “I think things are going to go well, I think we are going to get it done.”

Asked what was “at stake” for his presidency amid the congressional wrangling this week, the president replied: “Victory is at stake.”

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