Navigating the U.S. Debt Ceiling
Photo Credit: Alexander Schimmeck, Unsplash
The U.S. debt limit, also known as the debt ceiling, is back in the news
The debt limit is the total amount of money Congress has authorized the U.S. government to borrow. A majority vote in both the House and Senate is required to raise the legislative cap to increase the debt limit. Congress is currently negotiating the debt limit because Republicans have a majority in the House and Democrats have a majority in the Senate and control the presidency. If the debt limit is not eventually raised or suspended, the U.S. Treasury would likely face a funding crisis that could impact a range of federal spending commitments. Though this scenario is unlikely, there are potential consequences to think through.
Strategists are spending a lot of time thinking through three scenarios:
A non-event where Congress passes a bill before any undue market stress (low likelihood, minimal impact)
Temporary financial stress until the current political standoff is broken (high likelihood, medium impact)
A non-resolution leading to a U.S. default and extreme financial stress (low likelihood, significant impact)
Analysts then assign a probability to each scenario and discuss positioning. In our view, it is all content for content's sake. Investors feel like they always need to analyze something to justify their current positioning, but only some actually act on the analysis. In the end, the analysis and events are simply noise. We have no reason to expect anything different this time.
Failure to raise or suspend the U.S. debt limit could strain financial markets
It is difficult to predict the exact outcome. Still, potential strains include falling asset prices, a global recession, a weaker USD, a U.S. credit rating downgrade, and a delay or impairment in government functions and services, such as social security checks, salary payments, and national park operations. The most worrisome risk is a downgrade of the U.S. government's credit rating, which could happen even if a hard default does not occur (i.e., S&P's downgrade in 2011). It would question the U.S. government's "full faith and credit" and likely increase Treasury yields across the curve. An increase in Treasury yields, often used as the risk-free rate to price loans and other credit securities, would flow through to businesses and individuals in the form of higher borrowing costs.
While monitoring debt limit negotiations, we focus more on what matters long-term
Our focus is on inflation, corporate earnings, and economic activity. Debt negotiations are a big event with significant potential implications for financial markets, and we acknowledge that negotiations will grab headlines, impact the narrative, and drive near-term returns and volatility.
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