The Debt Ceiling and How It Impacts Your Portfolio
May 23, 2023
The debt ceiling has made its way back into the headlines this year, as the House of Representatives and the Biden administration continue to hold firm to their positions. Investors, in turn, have kept a close eye on the ongoing debates as they weigh what each possible outcome could mean for their portfolios.
But just how much does the debt ceiling debate impact markets, and more importantly, what does it mean for your portfolio?
A look back at the history of the debt ceiling may be able to shed some light on the current situation.
What Is the Federal Debt Ceiling?
In 1917, Congress set a limit on the amount of debt the federal government can carry. Currently, the government’s total debt is $31.4 trillion.1 That is the limit Congress approved in December 2021.
The ceiling can be raised only with Congressional approval, and as with many topics that come before Congress, it has historically been subject to partisanship. However, a vote to raise the debt ceiling does not explicitly give the government permission to spend more. It simply provides approval for the Treasury to borrow more to cover the costs of already approved spending.
What Happens if the Debt Ceiling Isn’t Increased?
If the debt ceiling is not lifted by the deadline and payments to investors in Treasury securities cannot be made, the U.S. government would technically to be in default.
The government might also have to freeze spending and go into shutdown, which could mean halting government spending, including Social Security payments, and salaries for government workers.
The shock of this scenario could cause turbulence in the stock and bond markets. Interest rates would likely increase, thereby raising consumers’ borrowing costs. The disruption could put the U.S. economy into a recession.
The Debt Ceiling Is Not a New Debate
For more than 90 years after a Congressional vote on the debt ceiling became a requirement, the decision was a routine exercise in Washington.
From 1960 to 2011, Congress acted 78 times to raise, extend, or redefine the debt limit. The issue only became a partisan debate starting in 2011, when prolonged debates over the debt ceiling that year and in 2013 proved to be costly.
In 2011, credit ratings agency Standard & Poor’s downgraded its rating of U.S. government debt. Estimates suggest the uncertainty for Treasury markets created by the delayed vote increased the government’s borrowing costs by $1.3 billion in 2011 alone.2
In 2013, the debate caused a partial government shutdown that lasted 16 days, as 800,000 federal workers were put on leave. Fortunately, this was the closest we have ever come to a full government shutdown and loan default scenario.
A Different Impact for Stocks and Bonds
History demonstrates the stock and bond markets can respond differently to debt ceiling negotiations. Since September 30, 1981, when the debt ceiling was increased by more than 5%, stocks fared worse in the three months after the decision than they did in the three months prior. Alternatively, bonds posted better returns in the three months after.
Intuitively, these varied responses make sense. Stocks responded less enthusiastically to the clear decision to increase the debt, because committing more spending to servicing the debt could mean slower economic growth. Alternatively, an end to concerns about the U.S. government defaulting on its debt brings relief for investors in bonds that would be adversely impacted by a default.
Perhaps the key conclusion to draw from this is that after a short period of volatility, stock and bond markets still delivered positive returns in the months leading up to and in the quarter after a vote on the debt ceiling. While the headlines may seem alarming, history suggests there is no need for investors to panic.
What Are this Year’s Deadlines?
The government hit the previously approved debt ceiling on January 19, 2023. The Treasury Department was able to delay the time Congress needs to vote by suspending certain intragovernmental debt and borrowing to fund programs and services for a limited time. The Congressional Budget Office (CBO) has estimated these measures will enable the Treasury Department to keep meeting its obligations only until July 1 of this year. However, U.S. Treasury Secretary Janet Yellen, recently warned the debt ceiling could be breached by June 1.3
What Can Investors Do?
In volatile periods, investors are often tempted to exit financial markets. Panicking, though, can adversely impact long-term returns. Markets often rally in sudden bursts, and trying to time when to exit and re-enter markets is nearly impossible to do with any consistent success.
While the thought of a government shutdown can understandably cause investors to make emotional decisions, history has shown that the volatility that surrounds the debt ceiling debate tends to be temporary. When that volatility does rear its head, it’s important to keep your long-term strategy in mind.
If you have questions about the current debt ceiling debate, and how it might impact your portfolio, please don’t hesitate to reach out to the team at Trinity Wealth Management.
The commentary on this website reflects the personal opinions, viewpoints, and analyses of the Trinity Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Trinity Wealth Management, LLC or performance returns of any Trinity Wealth Management, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Trinity Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Sources:
- “What is the national debt?” U.S. Treasury, May 2023
- “Debt Limit: Analysis of 2011-2012 Actions Taken and Effect of Delayed Increase on Borrowing Costs.” U.S. Government Accountability Office, July 23, 2021
- “Treasury Secretary Yellen reaffirms U.S. could run out of money to pay bills by early June,” CNBC, May 15, 2023