Stocks are primed for a precipitous drop if the U.S. fails to raise the debt limit and delays government payments.
That’s the warning from a team of UBS strategists. Although it’s unlikely, if the U.S. formally defaults and delays all payments beyond principal payments for a week, the S&P 500 will fall as much as 20% toward 3,400, the team led by economist Jonathan Pingle said.
In that case — one of four outlined by the bank — the country could shed at least 265,000 jobs and take a 0.3 percentage point hit to gross domestic product. The S&P 500 would stay suppressed before slightly rebounding to end 2023 near 3,700.
That’s well below the 3,800 to 4,200 levels the benchmark has been stuck in all year. The gauge was testing the upper end of that range on Friday amid optimism that debt-ceiling talks were progressing. In the bank’s most bearish set-up, the S&P would end the year near the strategists’ expected recession lows of 3,400 to 3,500.
A default isn’t in the bank’s base-case scenario, however. What’s most likely is that the U.S. will lift the debt ceiling with minimal fiscal drag in the near term, the strategists wrote in a note Friday. The team’s base-line S&P 500 year-end price target is 3,900, trailing the average analyst year-end target of 4,017. They put the odds of going past the X-date — the point at which the U.S. government loses its ability to meet all its obligations — at a one-in-four chance.
While fears of a debt-ceiling impasse have ramped up volatility in options and dislocated the short-end of the Treasury curve, stocks have remained largely unbothered. The S&P 500 is poised for its best week since the end of March, and the implied volatility levels for a Citigroup basket of companies whose sales rely the most on the government has fallen since the beginning of the year. Friday morning, House Speaker Kevin McCarthy indicated that both sides of the government may reach an agreement as soon as this weekend to avoid a catastrophic U.S. default.
The worst-case scenario outlined by UBS would be marked by a prolonged, one-month delay in all U.S. payments. That would lower GDP by an additional 0.8 percentage points, add 700,000 job losses and cause a 30% “immediate” drop in stocks — though they stressed — this scenario is “very unlikely.”
“At the moment, we see reasonable odds, roughly 50%, that Congress passes a short-term extension. However given the two sides ruling that out, our assessment could be very wrong,” said the strategists.
