This article was originally published on Friday, May 26th. As of Tuesday, May 30th, a deal has been reached by President Biden and House Speaker Kevin McCarthy, but still requires congressional approval.
What’s New
Negotiations around the U.S. debt ceiling continue to generate headlines as Treasury Secretary Janet Yellen’s June 1 deadline inches closer. The debt ceiling is the statutory limit on the Treasury’s ability to issue new federal debt. In other words, it’s a limit to how much the government is allowed to borrow to meet its existing legal obligations.
Earlier in the month, Yellen warned we may reach the debt ceiling on June 1, 2023. On May 25, 2023, credit-rating agency Fitch put the U.S.’s AAA credit rating on “Rating Watch Negative” based on concerns that the debt limit will not be raised in time to avoid missing payment obligations.
Investment markets seem to show signs of stress in correlation with debt ceiling tensions with higher rates across the yield curve, increasing borrowing costs to the government and taxpayers. Yields on Treasury bills maturing in early June have surged above 7% amid fears of a default.
However, Congress and the White House seem to be closer to striking a deal to suspend or raise the debt ceiling (an event that has happened over 100 times since 1917), and both Democrats and Republicans have displayed signs of optimism that a deal will get done. Some gaps in negotiations remain, and any deal will still face procedural hurdles as it makes its way through Congress, but the expectation is still that the U.S. will not default on its debt.
If a default does occur, we’re likely to see elevated near-term volatility in both stocks and bonds. It’s also likely that the Fed and/or other government agencies would take action to calm the markets.
What It Means
It's becoming more likely that a final deal will not occur by June 1, as crafting legislation and obtaining Congressional approval takes time. The Treasury does have a few options to delay a default, such as selling bonds from government trust funds or tapping into the Federal Financing Bank or its $500 billion in gold reserves. The government can also slow down the processing of payments from the Department of Defense and Centers for Medicare and Medicaid Services. If Congress needs more time to approve a deal, we could see a short-term extension of a few weeks.
Using these extraordinary measures, the Treasury can buy some time while a deal gets done. The next key date to watch is June 15: tax collection day.
Regardless of when the deal ultimately gets done, the Treasury will need to refill its coffers, which have been completely depleted, meaning Treasury issuance will likely explode after the target date. One estimate by Morgan Stanley suggests $700 billion of issuance this year that will drain liquidity from the system.
How It Impacts Your Portfolio
Rates have moved modestly higher across the yield curve over the past month as investors fear that this could move the economy closer to a recession. Despite the uncertainty, equity markets have remained relatively flat, as the S&P 500 is down just -1.15% in May through 5/24. If a deal is not reached by early June, equity volatility will likely increase.
The cost of insuring U.S. debt continues to rise. Credit Default Swaps —derivatives that measure the cost of insurance against default—remain extremely elevated at nearly double the cost to insure debt in 2011, when credit-rating agency Standard & Poor’s downgraded U.S. debt for the first time.
The DXY Index, which measures the U.S. dollar against a basket of foreign currencies, is up a modest 2.35% this month but overall is lower by 9.3% since last September. The DXY rises when the U.S. dollar gains strength relative to foreign currencies and falls when the dollar weakens. A weaker dollar could make international equities more attractive relative to the U.S.
The Roundtable™ Perspective
An actual default of U.S. debt would be unprecedented, so it’s difficult to determine the extent of potential outcomes. Most agree that a default would do significant harm to our economy. Not only would it result in a higher cost of borrowing, but it could also jeopardize the U.S. dollar’s status as the world’s reserve currency.
Luckily, markets have proven to be resilient when faced with challenges like the one we’re facing today. The table below shows how the S&P 500 performed immediately before and immediately after the eerily similar 2011 debt ceiling crisis, as well as the government shutdown of 2018. In both instances, the index was down in the weeks preceding the event, but 90 days later, it was back in positive territory.
S&P 500 Performance Before & After Recent Crises
Source: FactSet
No portfolio is immune to volatility in the short term, but at Wealth Enhancement Group, we craft your portfolio to withstand periods of economic uncertainty and seize opportunities in times of market upheaval. Since history shows that markets have proven to bounce back after events like this, we believe our “all-weather approach” should dampen potential long-term impacts.
If you have further questions, or if you’d like to speak with an advisor about how the current debt situation could impact your finances, please don’t hesitate to reach out.
This information is not intended as a recommendation. The opinions are subject to change at any time and no forecasts can be guaranteed. Investment decisions should always be made based on an investor's specific circumstances. Past performance is not a guarantee of future results.
