Breaching the debt ceiling – which could result in a default – would likely have disastrous ramifications for the US government and economy, as well as global financial markets.

As the US shutdown continues into its second week, many markets have experienced sharp losses as fears mount the heavily politicised process could still be in standoff come deadline day.

Here, T. Rowe Price provides all you need to know about the debt dramas and what could happen if the ceiling is not raised.

What is the debt ceiling and why is the 17 October significant?

Under current law, Congress authorises the US Treasury Department to issue the debt securities needed to fund federal government operations up to a stated limit, or ceiling. The current debt limit is $16.699trn. It was increased to that level earlier in 2013.

In late September, US Treasury Secretary Jack Lew notified congressional leaders that the Treasury would have only about $30bn by 17 October – not enough to pay all of its expenditures in the near future.

How will the Treasury operate if the debt ceiling is not raised?

Without a debt ceiling increase, the Treasury will have no authority to borrow additional money to finance daily federal government expenditures. If this happens, the Treasury would have to align spending with revenue, which would require an immediate and significant reduction in spending. Failure to raise the debt limit would require the government to cut spending by 15%-20%.

Without lifting the debt ceiling, what can the Treasury do to avoid missing bond interest or principal payments?

Even if the debt ceiling is not increased, the Treasury will continue to receive tax revenues that could be used to service the interest on the national debt. That would require prioritising debt-servicing expenditures over others. The Treasury can also continue to auction debt securities on a regular basis, but only to replace maturing issues so there is no net increase in government debt. In addition, according to a 1985 report from the Government Accountability Office: ‘the Treasury is free to liquidate obligations in any order it finds will serve the interests of the United States’. Significant asset liquidation seems unlikely.

Is the Treasury likely to prioritise some of its obligations?

It is unclear how the Treasury will act if the debt ceiling is not lifted in time. The Treasury could defer nonfinancial expenditures – for example Social Security payments – in order to maintain debt service, but it does not have a clear legal basis for doing so. Legislation passed by the House of Representatives in May would permit the Treasury to prioritise its payments, but the bill has not been passed by the Senate. Lew says prioritising some payments over others as ‘simply default by another name’.

How would rating agencies respond to a US default?

S&P has already warned that it would lower the US sovereign rating to Selective Default if the government fails to service a debt obligation. Similarly, Fitch could reduce the rating to Restrictive Default.

Even if the debt ceiling is raised, could there be another US debt downgrade?

T. Rowe Price sovereign credit analysts believe a credit rating downgrade could occur in any of these three situations:

• The agencies reassess US political institutions and the ‘willingness to pay’, determining that it is no longer consistent with their current rating

• As we get close to the debt ceiling, the agencies may pre-emptively change the outlook on the rating, or downgrade it slightly, to reflect the elevated risk environment

• If the US actually defaults, then the US would be downgraded to a default rating

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How would treasuries and other government-backed securities respond to a US government default or downgrade by one or more major credit rating agency?

A one-notch downgrade of US treasuries would likely create short-term market volatility. However, it would not, on its own, be the catalyst for a crisis. Some believe US treasury yields could rise, and other government-backed debt securities – such as Ginnie Mae, Fannie Mae, Freddie Mac, and Sallie Mae securities – could be affected too. But that outcome is not assured. Treasury yields actually fell sharply in the months following the August 2011 downgrade, though there were other factors – such as the eurozone debt crisis – that likely contributed to the decline.

A default would be a much more serious problem, but we believe this outcome is highly unlikely at this time. In a default scenario, US debt could be rated D for some period, and forced sales of treasuries by investors would probably create high volatility and illiquid market conditions.

Would higher treasury yields lead to higher bond yields in other sectors of the bond market?

Over the long term, we believe the economy, inflation, and the Federal Reserve’s monetary policy will be the primary drivers of interest rate movements. If treasury yields rise in response to a credit rating downgrade, yields on other securities that are backed by the full faith and credit of the US government or linked to its rating (such as Ginnie Maes) would probably rise, and the yield spread between treasuries and these sectors could increase modestly.

How would global fixed income markets respond to a US downgrade?

There could be a flight to quality – at least for a short time – in which investors sell or avoid higher-risk assets in favour of high-quality fixed income assets globally or other perceived safe havens.

How would global equity markets respond to a US default or downgrade?

In the event of a downgrade, there could be a flight to quality – at least for a short time – in which investors sell or avoid higher-risk assets in favour of high-quality fixed income assets globally or other perceived safe havens. That is what we saw in 2011, specifically in emerging markets. A default would have much greater repercussions.