The fight over raising the debt ceiling is likely to augment market volatility over the next six months. Fortunately, we expect the issue to be resolved before any damage is done, and the possibility of a default on U.S. government debt is extremely low. In the event of a default, all bets are off, but the potentially catastrophic damage wrought by such a scenario means that investors shouldn\u2019t ignore this issue entirely. If the worst does happen, there are few good options for investors.<\/p>\n
What Is the Debt Ceiling?<\/h2>\n
First, what is the debt ceiling? When Congress enacts plans for federal spending, it doesn\u2019t automatically authorize additional debt needed to pay for spending in excess of revenue. Instead, a separate process must periodically occur where Congress raises the limit on federal government debt outstanding.<\/p>\n
For decades, this procedural quirk caused little turmoil, but this started to change in the 1990s as the debt ceiling became the arena for partisan squabbling. This reached a fever pitch in 2011 during the Obama administration, when fiscally hawkish House Republicans blocked the raising of the debt ceiling for several months. To be clear, raising the debt ceiling itself authorizes no additional spending\u2014it merely allows debt to be issued to pay for spending that\u2019s already been passed. But lawmakers have sometimes sought to use the debt ceiling as negotiating leverage in order to force through spending cuts.<\/p>\n
A deal was ultimately reached to avert crisis in 2011 but not before sparking fears for several months that a cash-strapped U.S. Treasury would be forced to default on payments of interest or principal on maturing debt.<\/p>\n
With Republicans having recaptured the House last November, this year brings many of the same circumstances as the 2011 debt ceiling standoff. Indeed, it\u2019s been reported that new House Speaker Kevin McCarthy, in order to secure support from his caucus to become speaker, made a pledge to not raise the debt ceiling without massive spending cuts.<\/p>\n So, what will the next several months bring? The debt ceiling was actually already reached on Jan. 19, when U.S. gross federal debt hit $31.4 trillion. That doesn\u2019t mean that a crisis has already arrived, however. For the time being, the federal government can meet its funding needs using its roughly $300 billion of cash on hand plus other \u201cextraordinary measures.\u201d Treasury Secretary Janet Yellen has advised that the cash could run out as soon as June, at which point default would become a strong possibility.<\/p>\n We believe that a majority of House members would prefer to raise the debt ceiling without any uproar, as there is little political upside in plunging the U.S. economy into crisis. But without approval from Speaker McCarthy, a bill to increase the debt ceiling can\u2019t reach the House floor through the usual channels. The problem lies in the fact that McCarthy needs nearly unanimous support among House Republicans in order to maintain his position. Perversely, the slim margin of the Republican majority (222 to 212) means that McCarthy is beholden to the furthest right members of the Republican caucus, who are vociferously against raising the debt ceiling without sweeping spending cuts.<\/p>\n The prospects of a deal being reached that would placate Democrats as well as the most extreme House Republicans look dim. The Biden administration is likely to insist on tax increases to go along with spending cuts in any deal, which would be anathema to the Republicans.<\/p>\n This would all seem to portend for no resolution for the debt ceiling crisis. However, there is a way for House Democrats to join with moderate Republicans to get the debt ceiling lifted without approval from McCarthy. This is an arcane procedure called the \u201cdischarge petition.\u201d A simple majority is enough for the discharge petition to work, meaning only six Republicans would need to join the 212 Democrats. We think a discharge petition is overwhelmingly likely to succeed\u2014either as a direct vehicle to bring the debt ceiling bill to the floor or by pressuring Speaker McCarthy to assent to a face-saving compromise. House members and their staffs are already laying the groundwork for a discharge petition.<\/p>\n Because of the nature of the procedure, the discharge petition route will take several months to execute fully. But we should have clarity sooner rather than later that the discharge petition is likely to be successful (whether on its own or as leverage).<\/p>\n We expect this effort to produce a two-year suspension of the debt ceiling, meaning the issue will disappear as a concern until the next Congress, in 2025.<\/p>\n The most likely outcome is a smooth resolution of the debt ceiling crisis. That said, given unfamiliarity with the discharge petition procedure, it wouldn\u2019t be surprising to see some market volatility until the issue is fully resolved.<\/p>\n In the off chance that the discharge petition fails or a deal can\u2019t be reached in time, Washington insiders have speculated on ways to avoid an outright default once the U.S. Treasury runs out of cash. Possible solutions include minting a \u201ctrillion-dollar coin,\u201d issuing Treasury debt at a large premium to face value, or invoking the 14th amendment to ignore the debt ceiling entirely. All of these proposed solutions are legally questionable, and the lack of certitude would hardly soothe the market. In a scenario where a deal isn\u2019t reached at first, it\u2019s more likely that we\u2019d see a large selloff in U.S. Treasuries, which shocks Congress into finally fixing the problem.<\/p>\n Other than the prospect of default, there\u2019s another way the debt ceiling issue could hurt the economy and markets. Back in 2011, the deal that finally lifted the debt ceiling entailed significant cuts of U.S. federal spending, amounting to about 0.75% of gross domestic product. This negative fiscal shock dragged on an economy that was still ailing from the aftermath of the Great Recession. However, this isn\u2019t a problem this time around. The \u201cdischarge petition\u201d route probably won\u2019t lead to large spending cuts. And even if they did occur, the Fed has room to cut interest rates in order to offset a negative fiscal shock.<\/p>\n What about the worst-case scenario, where a significant and prolonged default on U.S. Treasury debt does occur? The outcome could be horrific, but in truth it\u2019s hard to say exactly what would happen.<\/p>\n We can try to get a clue on how markets would react by looking at the 2011 debt ceiling episode, but this provides only marginal insight. Treasury yields actually fell in the months prior to the 2011 lifting of the debt ceiling, probably because of the impact of other macroeconomic factors like the eurozone crisis.<\/p>\n Another spat over the debt ceiling in 2013 led one-month Treasury bill yields to briefly shoot up by 30 basis points relative to one-year yields. This means that investors were worried about soon-to-be maturing debt failing to be repaid. But this yield spike faded within days, and it never showed systemic impact in bond markets.<\/p>\n It\u2019s safe to say that markets have never priced in more than a very low probability that the debt ceiling crisis causes a major default. Should such a default occur, then we\u2019re in uncharted waters in terms of market and economic impact.<\/p>\n Presumably, Congress would ultimately step in to lift the debt ceiling after weeks of chaos. It could even make Treasury investors whole by paying up on missed payments and accrued interest. It\u2019s quite possible then that markets could shrug off the default as a temporary, technical error. But it\u2019s also possible that the default could lead to severe and irreparable damage.<\/p>\n U.S. Treasuries have long performed as a safe haven asset, and because of that attribute, they carry a very low yield compared with the expected return on investing in stocks and other risky assets. But Treasuries are a safe haven in large part because investors think<\/em> they are a safe haven. Most other developed countries\u2019 government bonds also benefit from such a dynamic, although to a lesser extent than the U.S., which has the special role of serving as the global reserve currency.<\/p>\n But a large enough shock, such as defaults from the debt ceiling impasse, could cause this self-reinforcing process to run violently in the other direction. Not only would investors\u2019 loss in confidence feed on itself but also rising yields would eventually cause an increase in the federal government\u2019s interest expense. This would cast doubt on the U.S. government\u2019s fiscal health, leading to further increases in yields.<\/p>\n Even though the last two decades have seen U.S. federal debt soar as a percentage of GDP, the burden of that debt is actually quite light as gauged by interest payments. Thanks to a steep decline in interest rates, interest payments on federal debt as a share of GDP are well below the peak reached in the 1980s. But if interest rates on government bonds jump higher because of a loss of confidence, the interest burden could become crippling. Paradoxically, by blocking the debt ceiling, the fiscal hawks in Congress could cause the very thing they hope to prevent: a collapse in the financial health of the U.S. government.<\/p>\n There\u2019s no good way for investors to prepare for a doomsday scenario where markets lose confidence in U.S. Treasuries, other than being maximally diversified, including exposure to developed-markets investments other than the United States. Gold could also provide protection\u2014gold prices surged by about 15% in the six months prior to Congress reaching a deal on the debt ceiling in August 2011. But in general, a collapse in confidence in U.S. Treasuries is likely to lead to a widespread plummet in global asset prices and a severe global economic recession.<\/p>\n Fortunately, for now, we have every indication that this catastrophe remains a very remote possibility. But investors won\u2019t be able to rest totally at ease until Congress finally deals with the debt ceiling.<\/p>\n<\/p><\/div>\n\n The fight over raising the debt ceiling is likely to augment market volatility over the next six months. Fortunately, we expect the issue to be resolved before any damage is done, and the possibility of a default on U.S. government debt is extremely low. In the event of a default, all bets are off, but …<\/p>\n","protected":false},"author":1,"featured_media":47067,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[161],"tags":[],"_links":{"self":[{"href":"http:\/\/www.brandon.ddtest.info\/multisite-test\/wp-json\/wp\/v2\/posts\/47066"}],"collection":[{"href":"http:\/\/www.brandon.ddtest.info\/multisite-test\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/www.brandon.ddtest.info\/multisite-test\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/www.brandon.ddtest.info\/multisite-test\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/www.brandon.ddtest.info\/multisite-test\/wp-json\/wp\/v2\/comments?post=47066"}],"version-history":[{"count":0,"href":"http:\/\/www.brandon.ddtest.info\/multisite-test\/wp-json\/wp\/v2\/posts\/47066\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"http:\/\/www.brandon.ddtest.info\/multisite-test\/wp-json\/wp\/v2\/media\/47067"}],"wp:attachment":[{"href":"http:\/\/www.brandon.ddtest.info\/multisite-test\/wp-json\/wp\/v2\/media?parent=47066"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/www.brandon.ddtest.info\/multisite-test\/wp-json\/wp\/v2\/categories?post=47066"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/www.brandon.ddtest.info\/multisite-test\/wp-json\/wp\/v2\/tags?post=47066"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}![\"Line](\"https:\/\/cloudfront-us-east-1.images.arcpublishing.com\/morningstar\/T7HFVBPZA5DRVIXZMQTH4XJVWA.png\")
<\/source><\/source><\/source><\/source><\/picture><\/span><\/p>\nHow the Debt Ceiling Fight Will Probably Play Out<\/h2>\n
Implications for the U.S. Economy and Investors<\/h2>\n
What Could Happen if a Major Default Occurs<\/h2>\n
![\"Chart](\"https:\/\/cloudfront-us-east-1.images.arcpublishing.com\/morningstar\/6EZKBIUNTNBNVIF2WQM6X3PZEE.png\")
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