How Would a US Debt Default Affect Latin America?

President Joe Biden’s discussions with Congress to raise the debt ceiling continue, with experts seeing a default unlikely but warning that the situation is having negative effects

Photographer: Kiyoshi Ota/Bloomberg
May 25, 2023 | 01:40 PM

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Bloomberg Línea — The odds of the US government defaulting appear to be minimal, and in fact, textbooks often refer to US debt as “risk-free”. However, the perilous situation that President Joe Biden’s administration is going through to get Congress to approve raising the debt ceiling could generate economic damage with an impact on the markets.

Analysts consulted by Bloomberg Línea do not assign many probabilities to a sovereign debt default in the world’s richest country, even though Treasury Secretary Janet Yellen has warned that this could happen on June 1, and that the yields of the notes maturing on that day are at 7%.

However, there are fears that this situation will push the government to the limit, increase the chances of recession, and affect risk appetite, thus impacting Latin America.

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Is there a risk of default?

The buzz of the last few days around the US government is due to a debate between the Biden administration and the opposition on the debt quota that the Congress grants to the government so that it can cover current expenses, investments, debt repayment, among other expenditure.


“The fact that the debt ceiling has been reached does not necessarily mean that there will be a default,” Jorge Angel Harker of Holistic and a correspondent in the US of Adcap Grupo Financiero.

“When agreements have not been reached, as happened in 2011, there ends up being operational problems for the government. What the Treasury does is to restrict the payment of certain things. Not necessarily debt, because debt is the last option, the nuclear option. Nobody wants to default on their debt,” Harker said.

Harker explained that what the US government does in these cases is to suspend certain payments.


“It sends home a lot of non-essential employees, for example. You don’t touch armed forces, medical personnel, air traffic controllers. But maybe you stop paying some suppliers and freeze social security payments,” he said.

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A deterioration in the economy

Harker said that the greatest risk is that the situation described above could accelerate a deterioration in consumption and push the economy into a recession. In this context, the US Treasury notes maturing on June 1, which is when the Treasury is supposed to run out of cash, is trading above 7%.

But the August note is trading below 4%. Harker said “it is as if the market were saying ‘maybe they won’t be able to pay on June 1 because they don’t have the cash, but in a couple of days they are going to do it’”.

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The impact on Latin America

Based on past experience, Harker explained that this type of situation can hit stocks, hit the euro and most likely weaken Latin American currencies, as a spin-off effect of lower consumption and recession. Counter-intuitively, the dollar and long-term Treasury bonds could be strengthened, as they are seen as safe-haven assets.


Diego Ferro, who chairs the M2M fund on Wall Street, said that this type of situation does not have a direct effect on Latin America, but it does have a collateral effect on what happens in the United States.

“It is very unlikely that there will be a default, but a noise in the market, even if it is resolved at the last minute, will generate a very large issue of Treasury bonds that is being postponed, and that will generate a fall in the reserves of the banks that will have to buy the bonds,” Ferro said.

On the other hand, Ferro considered that if this happens there will be noise in the funding market, which may generate some stress in the markets and, therefore, less risk appetite. The latter tends to have an impact with a fall in flows to Latin America.


Even with these warnings, Ferro clarified: “It is a conjunctural issue, nothing structural”.

He added that some investors speculate on the possibility that a recession in the US might generate an appetite for other markets, although he said this is only a medium-term hypothesis.

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Republicans distrust Yellen

Meanwhile, House Republicans do not believe Yellen’s warning that the US government will run out of money as soon as June 1, nor her predictions of default, are true.

“We’d like to see more transparency on how they’ve gotten to that date,” House majority leader Steve Scalise told reporters after a closed-door meeting on Tuesday, according to Bloomberg.


“It looks like they’re now hedging and opening the door to delaying that date,” Scalise said.

One House Republican, who asked not to be named while speaking candidly about his party’s assessment, said he believes the US should stop paying government salaries first if the Treasury exhausts its extraordinary measures to pay the bills before Congress allows it to borrow more.

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