The debt ceiling has been a simmering issue in Washington since mid-January, when the federal government first reached its mandated limit on borrowing. Now as temperatures rise in spring, the debt ceiling debate is likely to heat up as well. While no one is entirely sure what will happen if the issue isn’t resolved, just the debate could lead to additional market volatility in the coming months.
Here’s what to know about the debt ceiling.
What is the debt ceiling?
The federal debt limit is set by Congress and represents the maximum the U.S. Treasury can borrow to cover the obligations of the U.S. government, including spending on previously approved programs as well as interest payments on outstanding debt, such as Treasury bonds. The country actually hit the ceiling back in January, but Treasury Secretary Janet Yellen implemented so-called “extraordinary measures” to provide the government with additional funding to continue to operate for several more months. It’s unclear exactly how long the government can continue to operate under these extraordinary measures (tax collections happening right now will have an impact), but without action in Congress, it is possible the U.S. will be prohibited from issuing additional Treasury bonds sometime in June or July.
What happens if the debt ceiling isn’t raised in time?
No longer being able to issue Treasury bonds would inhibit the government’s ability to fund normal operations and might lead to it defaulting on certain interest payments or return of principal to bond holders. However, it’s unclear exactly how this scenario would play out since Congress has always raised the debt ceiling before the Treasury has exhausted sources of funds. If we got to that point, the government would have to make decisions about what payments would get prioritized and what payments would get missed. Options could include furloughing federal employees, suspending interest payments on outstanding debt or possibly cutting benefit payments for things such as Social Security or Medicare. A default would also be disruptive to the highly liquid and efficient Treasury market, which would likely have a significant impact on fixed income markets as a whole. Put simply, there is no blueprint for what happens if the debt ceiling isn’t lifted in time.
Could there be any impact before that time?
In 2011, Congress came close to allowing the government to default on its debt. While the situation was resolved two days prior to the date at which the Treasury estimated the borrowing authority of the U.S. government would be exhausted, there were still real impacts.
Standard and Poor’s downgraded the United States’ credit rating for the first time in history. The delay in raising the debt ceiling contributed to markets plummeting around the world and increased borrowing costs for the U.S. The S&P 500 dropped about 16.5 percent in the five weeks prior to when Congress finally agreed to increase the debt ceiling through the passage of the Budget Control Act of 2011, which became law on August 2, 2011. While there were additional global financial challenges at the time, the impasse in the U.S. is considered a driving force in declines at the time.
How many times has Congress raised the debt ceiling?
Since 1960, Congress has raised the debt ceiling 78 times, with the most recent increase occurring on December 16, 2021. At that time, the debt limit was raised by $2.5 trillion to $31.4 trillion. While there is speculation that the growing polarization in Washington will make an already arduous process more difficult, we believe that the two sides will come to an agreement before the government runs out of money to pay its bills. However, we would not be surprised if, as X date (the date at which the government will run out of funding options) approaches, there is heightened volatility in the markets as news coverage of the topic begins to generate greater awareness and both sides maneuver for negotiating position.
A default by the U.S. government could trigger financial upheaval. As such, both parties have a vested interest in reaching an agreement. Neither party wants to be tagged as being the cause of what could potentially be severe economic disruption. However, it is for this same reason that negotiations can be heated, with both sides trying to leverage the gravity of the situation to achieve their goals.
Is there anything I should do to prepare?
The uncertain nature of the outcome of negotiations underscores why we believe it can be risky to make wholesale changes to your investment plan based on expectations of how things may play out.
While no financial plan can predict the specifics of every bump along the way, a financial advisor can develop a plan that accounts for the unknown — whether from the debt ceiling or some other challenge that has yet to be identified.
A financial plan with investments alone is more susceptible to the economy’s twists and turns. But a plan in which your investment strategy is reinforced with a range of financial options built for your life and priorities, like cash value life insurance for protection and annuities for guaranteed income in retirement, can give you more options, more flexibility and more confidence.
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