What’s Next For Markets as the U.S. Reaches its Debt Limit?
on
February 15, 2023
The clock is ticking on the U.S. debt limit, which was already technically reached on January 19, 2023. The U.S. Treasury will take emergency measures, which are expected to extend the most severe impacts of the debt limit by several months, will be exhausted in June 2023.
About the Debt Ceiling
The U.S. government funds much of its spending through debt, which is issued by the Treasury. The current limit is $31.4 trillion. Raising this limit would allow the government to borrow more to cover spending already approved by Congress. Failure to raise the ceiling would mean the government would eventually fail to pay back its debts, including interest payments on Treasury bonds — technically putting the U.S. government in default. Over the years, this limit has been increased many times. According to the Treasury, Congress has increased the debt ceiling in some form 78 times since 1960.
Raising the debt limit used to be a routine exercise for Congress but it has become increasingly fraught. A potentially huge political fight looms this year as some House Republicans have vowed to block any increase in the debt limit in order to extract spending cuts. That’s a big concern given that a U.S. debt default would have potentially huge consequences for the economy and markets, raising doubt about the country’s creditworthiness.
What would it mean for the Treasury to “default?”
A bond default is a term for not making full and timely payment on any piece of debt, including interest or principal (the amount originally borrowed). Treasury bonds are very much the backbone of the entire global financial system. They are used around the globe as the safest of assets. This includes everything from banks using them as collateral to whole nations using Treasuries as foreign currency reserves. A true default could throw financial markets into chaos. 2011 was the closest Congress has come to not raising the debt ceiling in a timely manner. Standard and Poor’s lowered the credit rating of the US from its highest rating of AAA to AA+, which it remains at today. Surrounding this period was substantial volatility, with the S&P 500 falling 16% from July 22nd to August 8th of that year before rebounding in October. However, Treasury bond prices rose during this period as global investors fled to safety, still viewing Treasuries as the safest asset.
Potential impact on the markets
In theory, a debt default would be a highly impactful event in markets. The credibility of U.S. government debt would also be impacted. Currently, the U.S. government enjoys relatively low borrowing costs compared to other government borrowers. If the forecasted June limit is reached, then similar to 2011 when U.S. debt was downgraded, financial markets’ current faith in U.S. government debt, may be questioned. Fear that the federal government may default on its obligations has driven market volatility in the past, but typically not until the default deadline is much closer.
Even though today’s headlines are full of news about the debt ceiling and the start of Treasury’s extraordinary measures, the stock market historically has not reacted until the default deadline is much closer. In the bond market, Treasury bills with maturities in mid to late summer are starting to see a premium in their yields that may reflect anxiety about the timing of a debt ceiling resolution. In previous debt ceiling episodes, short-term Treasury bills and risk assets declined as the drama unfolded, then rebounded once an agreement was reached.
While the path to a resolution is uncertain, it is unlikely the United States will default. A default would be an unprecedented event that would have dramatic and unpredictable repercussions in the global financial markets. The debt ceiling situation is only one factor among many that is likely to impact the markets in the months ahead. Investors continue to focus on economic, jobs and inflation data, as well as the Federal Reserve’s interest-rate strategy, all of which are have a large effect on investor sentiment in the coming months.
However, as 2011 showed, if the government does delay raising the ceiling too long, then the economic impact on the U.S. could be severe, especially at a time when recession fears are high. Thus, we could see some short-term volatility with a debt ceiling debate even if it doesn’t come to an actual default. And at a certain point, measures to avoid a debt default might push the U.S. into recession – if for example, Social Security payments or paychecks to government employees were delayed. So it’s unclear how far the Treasury could push a technical default beyond June, and how damaging the economic impact would be from juggling the accounts.
Currently, the U.S. yield curve is deeply inverted, a common recession signal and further issues with the debt limit may disrupt the U.S. economy at a precarious time. The political composition of the legislative and executive branches of government today are nearly identical to what they were in 2011. Investors need to prepare for a possible repeat of 2011. We believe investors should have a disciplined, rules-based investment approach, and look to own assets which can perform well in recessionary environments to mitigate risk and potential volatility and market swings.
Still have questions about your investment portfolio or retirement strategy? We’ve helped many investors plan for their future. Contact Paraiba Wealth Management at contact@paraibawealth.com or (415) 742-8223 for a complimentary consultation.
Investment advisory and financial planning services are offered through Paraiba Wealth Management LLC, a Registered Investment Adviser. Intended for educational purposes only. Opinions expressed are not intended as individualized investment advice or a guarantee that you will achieve a desired result. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.
The clock is ticking on the U.S. debt limit, which was already technically reached on January 19, 2023. The U.S. Treasury will take emergency measures, which are expected to extend the most severe impacts of the debt limit by several months, will be exhausted in June 2023.
About the Debt Ceiling
The U.S. government funds much of its spending through debt, which is issued by the Treasury. The current limit is $31.4 trillion. Raising this limit would allow the government to borrow more to cover spending already approved by Congress. Failure to raise the ceiling would mean the government would eventually fail to pay back its debts, including interest payments on Treasury bonds — technically putting the U.S. government in default. Over the years, this limit has been increased many times. According to the Treasury, Congress has increased the debt ceiling in some form 78 times since 1960.
Raising the debt limit used to be a routine exercise for Congress but it has become increasingly fraught. A potentially huge political fight looms this year as some House Republicans have vowed to block any increase in the debt limit in order to extract spending cuts. That’s a big concern given that a U.S. debt default would have potentially huge consequences for the economy and markets, raising doubt about the country’s creditworthiness.
What would it mean for the Treasury to “default?”
A bond default is a term for not making full and timely payment on any piece of debt, including interest or principal (the amount originally borrowed). Treasury bonds are very much the backbone of the entire global financial system. They are used around the globe as the safest of assets. This includes everything from banks using them as collateral to whole nations using Treasuries as foreign currency reserves. A true default could throw financial markets into chaos. 2011 was the closest Congress has come to not raising the debt ceiling in a timely manner. Standard and Poor’s lowered the credit rating of the US from its highest rating of AAA to AA+, which it remains at today. Surrounding this period was substantial volatility, with the S&P 500 falling 16% from July 22nd to August 8th of that year before rebounding in October. However, Treasury bond prices rose during this period as global investors fled to safety, still viewing Treasuries as the safest asset.
Potential impact on the markets
In theory, a debt default would be a highly impactful event in markets. The credibility of U.S. government debt would also be impacted. Currently, the U.S. government enjoys relatively low borrowing costs compared to other government borrowers. If the forecasted June limit is reached, then similar to 2011 when U.S. debt was downgraded, financial markets’ current faith in U.S. government debt, may be questioned. Fear that the federal government may default on its obligations has driven market volatility in the past, but typically not until the default deadline is much closer.
Even though today’s headlines are full of news about the debt ceiling and the start of Treasury’s extraordinary measures, the stock market historically has not reacted until the default deadline is much closer. In the bond market, Treasury bills with maturities in mid to late summer are starting to see a premium in their yields that may reflect anxiety about the timing of a debt ceiling resolution. In previous debt ceiling episodes, short-term Treasury bills and risk assets declined as the drama unfolded, then rebounded once an agreement was reached.
While the path to a resolution is uncertain, it is unlikely the United States will default. A default would be an unprecedented event that would have dramatic and unpredictable repercussions in the global financial markets. The debt ceiling situation is only one factor among many that is likely to impact the markets in the months ahead. Investors continue to focus on economic, jobs and inflation data, as well as the Federal Reserve’s interest-rate strategy, all of which are have a large effect on investor sentiment in the coming months.
However, as 2011 showed, if the government does delay raising the ceiling too long, then the economic impact on the U.S. could be severe, especially at a time when recession fears are high. Thus, we could see some short-term volatility with a debt ceiling debate even if it doesn’t come to an actual default. And at a certain point, measures to avoid a debt default might push the U.S. into recession – if for example, Social Security payments or paychecks to government employees were delayed. So it’s unclear how far the Treasury could push a technical default beyond June, and how damaging the economic impact would be from juggling the accounts.
Currently, the U.S. yield curve is deeply inverted, a common recession signal and further issues with the debt limit may disrupt the U.S. economy at a precarious time. The political composition of the legislative and executive branches of government today are nearly identical to what they were in 2011. Investors need to prepare for a possible repeat of 2011. We believe investors should have a disciplined, rules-based investment approach, and look to own assets which can perform well in recessionary environments to mitigate risk and potential volatility and market swings.
Still have questions about your investment portfolio or retirement strategy? We’ve helped many investors plan for their future. Contact Paraiba Wealth Management at contact@paraibawealth.com or (415) 742-8223 for a complimentary consultation.
Investment advisory and financial planning services are offered through Paraiba Wealth Management LLC, a Registered Investment Adviser. Intended for educational purposes only. Opinions expressed are not intended as individualized investment advice or a guarantee that you will achieve a desired result. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.
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