Investing Through a Debt Ceiling Crisis
As of January 19, 2023, the US debt limit is once again in focus and has reached the ceiling, forcing “extraordinary measures” to be taken. The debt ceiling is the maximum amount of money the Treasury is permitted to borrow to pay its obligations. As it stands the current debt limit is $31.4 trillion. Extraordinary measures are a way for the government to move around money to pay their obligations.
Treasury Secretary Janet Yellen sent a letter to Congress urging them to take swift action and outlined what those extraordinary measures would be, mainly the suspension of payments to the Civil Service Retirement and Disability Fund and the Postal Service Retiree Health Benefits Fund. These measures, according to Yellen, should be sustainable until June, giving Republicans and Democrats time reach a deal to raise the debt ceiling.
Debt ceiling concerns have caused market volatility in the past, however typically much closer to the deadline. This time concerns about a deeply divided Congress have rattled investors nerves. An agreement must be reached to raise the debt limit to allow the government to borrow more to cover spending already approved by Congress and failure to do so would put the US government in default, failing to pay interest on Treasury securities. Republicans want to negotiate spending cuts before agreeing to raise the debt limit. In the debt crisis of 2011, the country came close to defaulting, causing the US credit rating to be downgraded by Standard & Poor’s from the highest level of AAA to AA+, where it remains today. This caused world equity markets to tumble on fears the US would not be able to meet their debt obligations.
Should investors be concerned over the possibility of default? Lauren Goodwin, economist and director of portfolio strategy at New York Life Investments, says the effects of the debt ceiling conflict could be "Household and business confidence plummets, and uncertainty about asset prices, borrowing costs and economic activity amid a default or shutdown can make households and businesses reluctant to spend.” Goodwin goes on to say, "Worse even, a debt-ceiling fight this year would likely increase the effects of the economic slowdown and even pull forward recession timing." Nevertheless, many experts agree that policy makers will eventually find a compromise, as they have in previous debt ceiling scenarios, and it is unlikely for the US to default on its debt obligations. In the last 40 years, the debt ceiling has been raised 45 times. The uncertainty on how long the debate will last could cause short-term turmoil in the market as we get closer to June, however, so far this year the market has widely ignored concerns on the debt limit. Unlike during the 2011 debt crisis, investors saw the S&P 500 declined 17% on debt ceiling concerns.
As a long-term investor, it is important to note that historically markets recover and by remaining in a diversified portfolio you can help manage risk in your investments.
Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.