Broker Check

The Retractable (Debt) Ceiling

May 12, 2023

Key Takeaways 

  • The government’s borrowing limit is estimated to run out by early June.  
  • Investors should prepare for potential volatility as increased partisanship in Congress will potentially only be resolved at the final hour. 
  • Investors should not make impulsive portfolio decisions solely based on debt ceiling risks.

The clock is ticking on US debt ceiling negotiations.  Treasury Secretary Yellen informed Congress that cash  balances are estimated to run out by early June, the so called X-datei. With the deadline fast approaching, markets  are sending signals about investor concerns. Treasury bills  with maturity dates in mid-summer are seeing higher  yields.While there is no playbook on how this showdown  will unfold, sadly, this is not our first rodeo either. 

We have been here before 

Since the enactment of the debt ceiling in 1917, Congress  has voted 102 times to either raise or suspend the limiti.This has taken place under both Democrat and Republican control. That's not to say things have gone smoothly in the  past either.  

In 2011, the debt ceiling debate went so far that the credit  rating agency, Standard & Poor’s, downgraded the USS credit rating to AA+ from AAAiii. Standard & Poor’s cited  the growing deficit and the prolonged debate as the  reasons for the downgrade.In 2013 and 2018, debt ceiling  standoffs led to government shutdowns. Each standoff, showdown, and shutdown led to short-term market  disruptions for days or weeks and subsequently recovered.  

Is this time different? 

It feels that the political debate today is even more  combative, with the potential for a stalemate ever greater  than in the past. Sadly, that is not a new development in  Washington. However, the one thing separating today’s  debt debate from those of the past is the larger-than-ever  national debt. US debt at $31.4 trillion, now stands at  120% of gross domestic product as of December 2022 and is projected to increase in the futureiv. The silver lining is that despite higher debt, the interest cost on our debt is  lower than the outlays in the 1980s and 1990sv. Nonetheless, the potential costs ahead are higher than in  years past. 

What are the paths ahead?

If a deal is reached before the X date, Congress could  suspend the debt ceiling for a short time to coincide with  the end of the fiscal year. Alternately given the upcoming election year, the most likely scenario is a last-minute agreement to raise the debt ceiling.  

If a deal is not reached and all of the Treasury’s cash  balances are drawn, the federal government will be forced  to rely on incoming revenues to pay its bill. This would require a prioritization in payments with principal and  interest payments to bondholders likely to continue while  other payments like government salaries and social  security benefits could be interrupted.  

If a bond payment is missed or delayed, that would  constitute a technical default. The chances for a technical default, while not zero, remain low given the potential implications. A default is not a winning political outcome  despite the hardline posturing from both parties to date. A default would most likely trigger a downgrade of US debt, increase the cost of borrowing, pressure the US dollar’s  reserve currency status, and disrupt short-term funding in financial markets. The subsequent market fallout will likely  apply significant pressure on lawmakers to find a quick  resolution. 

What should investors do?

Understandably, the debt ceiling drama has investors on  edge. Investors should resist the urge to make impulsive  portfolio decisions solely based on debt ceiling risks.  Instead, they should remain focused on long-term goals  and rely on diversification within their portfolio. For instance, consider precious metals like gold, currencies  like the Japanese yen or, the Swiss franc, or even  international equities where appropriate. However, given  the potential for increased market volatility, investors  should ensure they have ample liquidity to meet near-term spending needs. Finally, looking past the near-term volatility, history suggests that stock markets tend to  rebound shortly following the resolution of the US debt ceiling crises. 

As history is our guide, let’s hope the retractable (debt)  ceiling is raised while finding a longer-term solution to the  escalating debt and deficit.  



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105841 | C23-19992 | 05/2023 | EXP 05/31/2023