What could happen to markets if the United States defaults on its debt?
The short answer is that we don’t know because, except for a technical glitch in 1979, the U.S. has never missed payments on its debt. But on August 2, 2011, the U.S. had a close call, with politicians resolving their differences at the eleventh hour.
Given that close call, equity markets fell sharply. The S&P 500 lost nearly 20% of its value, while small and mid-cap stocks fell by over 25%.
Among equity sectors, regional banks and financial stocks were among the hardest hit, losing around one-third of their value. As equity prices fell, bond prices soared, driving the yield on the 10-Year U.S. Treasury down by 200bps even as the ratings agency S&P downgraded U.S. debt from AAA to AA+. Meanwhile, gold prices soared by $400 per ounce.
2011 is just one data point, and in 2023, both the political and market dynamics are different. In 2011, the U.S. economy had low inflation, zero rates and quantitative easing. The current budget and debt ceiling debate occurs in the context of 5.5% core inflation, rising interest rates and quantitative tightening. Therefore, what happened in 2011 may or may not be a useful guide to what could happen this year.
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