After months in and out of the headlines, the debt ceiling issues have become a sharp focus. As we write this, lawmakers are racing to advance legislation before the new June 5th deadline, when the U.S. may be unable to pay all of its bills. Many are understandably nervous, and it’s still unclear how this will ultimately play out.
How can we maintain perspective around political and fiscal uncertainty? We can start with understanding what the debt ceiling is.
The federal government often operates with a budget deficit, as spending on things like defense, Social Security payments, and emergency pandemic stimulus checks exceed government revenues, primarily from taxes.
As the economy grows, tax revenues increase. Over time, these tax revenues are outpaced by spending. The federal government borrows money to pay its bills by issuing Treasury securities, which adds to the national debt and hit the $31.4 trillion debt ceiling in January. Since then, the Treasury Department has employed “extraordinary measures” to ensure the country doesn’t default on its obligations.
Why is this an issue?
The debt ceiling is a mechanism that requires Congress to approve additional borrowing above these levels. Democrats and Republicans have been in a standoff but made good progress over the Memorial Day weekend. As of Tuesday, May 31st, the House and the Senate still need to pass the deal. Ultimately, getting the bill passed and signed into law by the June 5th deadline remains tight.
What information do we have?
The latest deal may calm nerves among markets and investors alike, as it suspends the $31.4 trillion borrowing limit until January 2025. This sets the debt limit at whatever level it reaches by the 2025 suspension and passes the hot potato to the next presidential administration.
Goldman Sachs summed the deal up this way: “Major reduction in uncertainty, minor reduction in spending.”
Why does this sound familiar?
A debt ceiling “crisis” is nothing new. According to the Congressional Research Service, the debt ceiling has been raised 102 times since World War II. Similar debt ceiling standoffs have occurred over the past decade, with the limit suspended and expanded in 2013, 2014, 2015, 2017, 2018, 2019, and 2021.
Fortunately, despite the headlines and investor concerns, these episodes had little long-term impact on markets. The one exception occurred in 2011 when a similar standoff led Standard & Poor’s, a credit rating agency, to downgrade the U.S. Debt and the S&P 500 to tumble19%. Ironically, the prices of Treasury securities increased. Why? Despite the downgrade, investors still believed Treasuries remained the safest in the world, even during heightened uncertainty. Ultimately, the debt ceiling was raised and a new budget was approved, allowing markets to bounce back.
What happens if a deal isn’t reached and the U.S. defaults?
Although this remains unlikely, a default would significantly impact the U.S. and across the globe. A few potential ramifications:
- Delayed payments of federal benefits – things like Social Security payments and veterans benefits
- Higher borrowing costs
- A potential downgrade of U.S. debt
- Increased market volatility
- Global recession
While we are not in the business of making predictions, it isn’t far-fetched to see that the ramifications would be hard-hitting.
What can we do?
Though we’ve been here before, there is still no clear understanding of how investors may be impacted. If an agreement isn’t promptly reached, investors may have to accept higher stock market volatility in the short term. While it may be tempting to sit on the sidelines until the negotiations are resolved, it’s important to remember that volatility goes in both directions–up and down–and very often, the market’s worst-performing days are followed by some of its best.
Investing in a well-diversified portfolio, owning safe bonds, and keeping a prudent cash buffer for shorter-term goals are the best antidotes to market volatility. In times of heightened uncertainty, staying focused on what we can control, maintaining a long-term perspective, and remaining disciplined are the keys to weathering whatever lies ahead.
Clear as Mud?
Have additional questions about the economy, markets, or your financial plan? Please reach out—we’d love to help.
Uplevel Wealth is a fee-only, fiduciary wealth management firm serving clients in Portland, OR and virtually throughout the U.S.
