U.S. President Joe Biden and House Speaker Kevin McCarthy (R-Calif.) reached an agreement to raise the national debt ceiling over Memorial Day weekend. The text of the legislation that reflects the agreement, following several long days of negotiation, was released on Sunday.
This is a tentative deal that would suspend the nation’s borrowing limit, currently at $31.4 trillion, for the next two years, until Jan. 1, 2025. Among other provisions, the deal puts in spending caps and reclaims unused COVID-19 funding, while paring back spending growth on nondefense outlays in 2024 at roughly the same level as in fiscal year 2023.
The nonpartisan Committee for a Responsible Federal Budget commented that if the legislation passes, it would be the “first major deficit-reducing budget agreement in almost a dozen years and would signal Washington is serious about making progress in addressing our mounting national debt.”
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Since Jan. 19, the Treasury Department has used “extraordinary measures” to come up with enough cash to pay the government’s bills on time. While it’s difficult to precisely nail down when these extraordinary measures will be exhausted (the so-called x-date), Treasury Secretary Janet Yellen said the nation could default on its obligations as early as June 5.
What triggered Yellen’s ominous forecast was the government’s weak tax receipts in April, which tallied 35% lower than the receipts received in April 2022. And while the x-date could occur in early June, other sources, including Moody’s Analytics, point to late July as a possibility because the Treasury will receive a cash infusion from non-withheld tax revenue around June 15 of this year.
The Limit, Save, Grow Act of 2023, passed in the House on April 26, provides a framework on which political figures on both sides of the aisle could negotiate the finer points of how the debt-ceiling limit will be managed. Also at issue are the cascading effects of those discussions on the government’s spending habits in the future.
Seventy percent of registered voters preferred a government compromise on the debt-ceiling debate, according to an NPR/PBS NewsHour/Marist national poll conducted in late February. Now, the ball is in Congress’ court, with not a lot of time to waste.
Read on for details about the national debt and what investors should be aware of as the debt-ceiling x-date nears:
— 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.
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 (causing) a long, drawn-out fight over the budget and debt ceiling,” says Lauren Goodwin, economist and director of portfolio strategy at New York Life Investments. “We expect disaster to be avoided, but there are costs to 11th-hour brinkmanship.”
Plummeting household and business confidence amid uncertainty about asset prices, borrowing costs and economic activity are consequences of a debt-ceiling crisis, Goodwin says. In the worst case, failure to act could “increase the effects of the economic slowdown and even pull forward recession timing,” she adds.
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 fell 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.
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Today’s Debt-Ceiling Debate vs. Past Conflicts
While many portfolio managers and strategists do not anticipate that this year’s debt-limit debate in Congress will mirror what happened in 2011, they quickly point out that the duration of the discussions could have unintended consequences in the market.
Knapp remarks, “Gridlock regarding the debt ceiling creates uncertainty that could eventually roil markets. So far, that hasn’t happened, likely due to investors’ belief that a solution to the problem will be found before a default occurs.”
“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.
Volatility is not exactly a new thing for the S&P 500. From 1957 through the end of 2022, the S&P has ended the year in the red 18 times, nearly 28% of the time. What’s intriguing, though, is that following those 18 negative-return years, it snapped back with positive returns 14 times. In fact, since 1957, there have only been three periods in which the S&P 500 has experienced consecutive years of negative returns (1973-1974, 2001-2002 and 2002-2003), according to data from Statista and Macrotrends.
But even if debate tensions fizzle before June 5 and the stock market averts excessive volatility, there are other, longer-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
Congress is expected to 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 Deadline: What Investors Should Know originally appeared on usnews.com
Update 05/30/23: This story was previously published at an earlier date and has been updated with new information
