A new Congress grapples with a familiar foe – the ‘debt ceiling’. While concern is warranted, past instances have delivered relatively muted responses from markets, largely because resolutions have ultimately been achieved before stop-gap resources were exhausted.
Whether or not this time is different will depend upon the progress of the upcoming political deliberations and investor perceptions of the potential for resolution in advance of the estimated deadline.
2023 Debt Ceiling
- The debt limit signifies the maximum amount the U.S. government can borrow. The current limit is $31.4 trillion. The debt limit has been in place since 1917. It has been raised or suspended 102 times.
- The U.S. reached the current debt limit in January of this year, at which point the U.S. Treasury initiated a series of established steps, known as the “extraordinary measures,” that allows the government to continue borrowing money to meet its obligations.
- Should those measures be exhausted before a new debt limit is passed by Congress, the government would be forced to delay making payments for some activities, default on its debt obligations, or both.
- When the Treasury will run out of funds is not entirely clear. Analyst estimates vary from June to August.
- The latest Congressional Budget Office (CBO) projection notes that the final date will be determined by tax revenues the IRS receives in April. Should those revenues decline significantly from CBO’s estimates, “the extraordinary measures could be exhausted sooner, and Treasury could run out of funds before July,” CBO director Phillip Swagel said in a statement in February.
Historical Market Impact
- U.S. stock-market performance around 14 government shutdowns since 1980, as well as debt-limit fiascoes in 2011 and 2013, has shown no major consistent reaction to the political turmoil related to the debt ceiling.
- Returns of other asset classes have been mixed. Not pictured in the chart below (due to scale) are shorter-term U.S. treasuries, like the 3-month treasury bill which saw yields skyrocket up 800% in 2011 and 900% in 2013 as fears over missed repayments soared.
- Unless Congress raises or suspends the debt limit, the federal government will lack the cash to pay all its obligations. How damaging this scenario would be depends on how long the situation lasts, how it is managed, and the extent to which investors alter their views about the safety of U.S. Treasuries.
- In October 2013, the Federal Reserve simulated the effects of a binding debt ceiling that lasted one month—during which time Treasury would continue to make all interest payments. It estimated that such an impasse would lead to the following:
- 80 basis point increase in 10-year Treasury yields
- 30% decline in stock prices,
- 10% drop in the value of the dollar
- Mild two-quarter recession, leading to an increase in the unemployment rate of 1.25 percentage points and 1.7 percentage points over the following two years. Such an increase in the unemployment rate today would mean the loss of 2 million jobs in 2022 and 2.7 million jobs in 2023.
The consequences of a failed resolution to the debt ceiling battle are significant enough to compel an agreement in advance of the Summer 2023 deadline. As the deadline approaches, market concern and potential volatility are likely to elevate. Whether this precipitates something worse than what we have seen in previous debt ceiling battles will depend upon the degree of confidence market participants have in a timely political resolution.