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While it is not customary for us to get out too far in front of unfolding issues, given all the media attention to the “debt ceiling crisis”, I believe it is appropriate to share my thoughts with you today to help reframe the context of the situation.
Current situation
The clock is ticking on US debt ceiling negotiations and 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. 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 limitii. 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 US 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 even 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 mostly 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 many of us on edge. We should resist the urge to make impulsive portfolio decisions solely based on debt ceiling risks. It’s our view that the debt ceiling will be resolved, and any market downturn will be temporary in nature.
As we have discussed many times in the past, the biggest risk to achieving long-term success is abandoning a well-constructed investment plan. At the same time, I recognize the potential emotional impacts of market volatility and continuous media coverage. If for any reason, the debt ceiling debate or potential market reactions are causing you undo stress and anxiety please contact us immediately. We are always here for you and happy to assist you in identifying options that may ease some of your angst.
Helping you live your BEST Life is our top priority, and in doing so, we live ours.
Thank you for the opportunity to serve you.
Warmest regards,
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