Bank economists warned on Tax Day that the U.S. government’s deadline to raise the debt ceiling could come earlier than anticipated. Weak capital gains tax inflows as of mid-April have the potential to shorten the time until the so-called X-date — when the government will be in default on its debt.
Goldman Sachs said that feebler April tax receipts than usual could cause the default date to be bumped up to the first half of June, much sooner than its earlier estimate of early to mid-August. Fortunately for investors, the full picture will be clearer once data on this week’s tax receipts becomes available.
How the Debt-Ceiling Crisis Escalated
When the U.S. government does not have enough cash on hand to meet its spending commitments, it often issues debt to make up the difference. There is, of course, a limit on the amount of debt the federal government can accumulate — currently $31.4 trillion — and that limit was exhausted on Jan. 19.
Treasury Secretary Janet Yellen penned two letters to House Speaker Kevin McCarthy in January, in which she requested an increase in the debt limit to keep the government running. Debt-ceiling talks to date are still gridlocked along party lines.
So ensued the Treasury Department’s “extraordinary measures” to obtain a borrowing cushion of roughly $800 billion to maintain the government’s cash-flow needs for the short term. Some investors wondered how well Congress would collaborate on core spending priorities and manage expectations along the way.
The Congressional Budget Office previously estimated that if the debt limit were not adjusted, the government’s ability to borrow even with extraordinary measures would run out between July and September 2023, and the U.S. wouldn’t be able to pay interest and principal to its lenders.
In light of recent events, economists have indicated that Congress will need to reach a debt-ceiling deal within weeks or risk the situation eventually snowballing into a recession.
Here’s what investors need to know about the pending debt-ceiling deadline and the potential impact on markets:
— How big is the national debt, really?
— Effects of debt-ceiling gridlock on investors.
— The debt-ceiling debate cycle.
— Today’s debt-ceiling debate vs. past conflicts.
— Long-term consequences of inflated U.S. debt.
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How Big Is the National Debt, Really?
The massive amount of U.S. debt is hard to visualize in scope and dimension. Just how much is $31.4 trillion?
Here’s one way to think about it: Earth is approximately 93 million miles away from the sun. If it were even possible, a spacecraft would need to take nearly 169,000 round trips to the sun to log 31.4 trillion miles. Expressed another way, the nonpartisan Peter G. Peterson Foundation estimates that if every single American decided to pitch in and pay off the national debt today, the cost would be more than $94,000 per person.
From 2013 through the end of 2022, the U.S. debt grew by nearly 86%, according to Treasury Department data. The debt to gross domestic product (GDP) ratio, a bellwether metric for a country’s ability to pay down its debt, also grew from 100% in 2013 to 124% in 2022.
Effects of Debt-Ceiling Gridlock on Investors
Markets as a whole are acutely aware of developments related to the debt ceiling. “Bond markets experienced utter carnage in 2022 for a host of reasons, including long-term concerns about newly accumulated government debt,” says Scott Knapp, chief market strategist at CUNA Mutual Group.
“There is a wide divide between Republicans who want spending cuts and Democrats who want to raise the debt ceiling, which is pointing to a long, drawn-out fight over the budget and debt ceiling. We expect disaster to be avoided, but there are costs to 11th-hour brinkmanship,” says Lauren Goodwin, economist and director of portfolio strategy at New York Life Investments.
“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 says. “Worse even, a debt-ceiling fight this year would likely increase the effects of the economic slowdown and even pull forward recession timing.”
[2023 Investment Outlook: When Will the Stock Market Recover?]
The Debt-Ceiling Debate Cycle
When it comes to raising the roof on U.S. debt, there appears to be a rinse-and-repeat pattern in play. Since 1960, Congress has produced 78 separate measures to raise, extend or amend the debt limit, according to the Treasury Department’s records. That’s an average of more than one piece of debt-ceiling legislation per year over the past six decades. Congress has never lowered the debt limit.
Because congressional debates about the debt ceiling are often mundane, investors don’t usually see an immediate effect from the process. There are some notable exceptions, however. Take, for example, investors’ cliffhanger experience in 2011, when congressional discussions about the budget reconciliation process stalled within the House and Senate chambers. The ensuing gridlock soured investor sentiment, and the S&P 500 plummeted 17.4% from May 2 to Oct. 4, 2011.
Further, America’s credit rating was downgraded by Standard & Poor’s from AAA to AA+ for the first time since 1917 on Aug. 6 of that year. The Bipartisan Policy Center estimates that the debt-limit debate in 2011 increased U.S. borrowing costs by $18.9 billion.
Today’s Debt-Ceiling Debate vs. Past Conflicts
While many portfolio managers and strategists do not anticipate this year’s debt-limit debate in Congress to mirror what happened in 2011, they quickly point out that the duration of the discussions could have unintended consequences in the market.
“We anticipate downside risk from debt-ceiling negotiations should they drag. Slowing economic growth and investor complacency from early 2023 could compound the volatility,” says Jon Maier, chief investment officer at Global X ETFs.
Even if debate tensions fizzle well before June, there are other, long-term challenges that the national debt poses for investors.
Long-Term Consequences of Inflated U.S. Debt
“Long-term debt sustainability is pure economics,” Goodwin says. “And, in a short period of time, tailwinds for U.S. debt sustainability have turned to headwinds, putting this debate back on investors’ map.”
Long-term issues associated with the size of U.S. debt include debt-serving costs that will rise in coming years and potentially weakening demand for Treasurys in a global economy that has alternative fixed-income options with positive yields, Goodwin says.
“Declining demand, even amid steady supply, would put durable upward pressure on U.S. bond yields, all else equal,” Goodwin says. “In other words, the U.S. might see an increase in its term premium — a sea change in global investing.” Term premium is the higher return that investors receive for committing to a long-term bond instead of rolling over shorter-term debt.
Takeaway
Perhaps Congress will once again find a way to hit the snooze button on the debt-ceiling debate and reach an agreement that will appease both political parties for now. And while the market may cheer that outcome in the short run, keen investors will remain curious about how the government will follow up. Hard questions remain about the size of the national debt and what it may mean to future generations if nothing substantial is done about it.
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U.S. Debt-Ceiling Clash: What Investors Should Know originally appeared on usnews.com
Update 04/19/23: This story was previously published at an earlier date and has been updated with new information.
