An impasse over the debt ceiling is becoming a real threat and the market is simply not appreciating its potential severity, said Aaron Kohli, Interest Rate Strategist at BMO. ‘If you get a situation where the debt ceiling is actually reached or breached I think the amount of volatility in stocks and even in bonds to some extent will be very extreme,’ said Kohli. Kohli added that the worst part about this type of volatility is that it’s difficult to predict the resulting winners and losers in the stock market. ‘Not only will the potential losses be random, you could have perfectly safe institutions suffer losses, but you may also have a situation where some equities do better and others do much worse depending on the cash positions and the safety of the securities versus the fact that the U.S. Treasury may actually not pay its debt,’ said Kohli. Kohli said the Federal Reserve will be forced to step in if Congress cannot come together and resolve the debt ceiling situation. One potential result of a prolonged debt crisis could be a delay in the Fed rate hike until much later in 2016 which would ultimately send stocks higher. He said the Fed is ready to hike rates, but is fearful of exogenous events like the inability to raise the debt ceiling.
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