Once again investors find themselves watching rival political parties in the U.S. wrangle over a path to raising the country’s debt ceiling. There is a sense of urgency to this process as estimates for when the U.S. Treasury runs out of funds could occur as soon as June 1. The government actually exceeded its borrowing authority in January. Since then, it has relied on “extraordinary measures” to meet its financial obligations. But these measures may soon be exhausted. Examples of these extraordinary measures include suspending investments in the Thrift Savings Plan for federal employees or suspending investments in the Civil Service Retirement and Disability Fund.
Current comments from individuals at the negotiating table reflect that the discussions are at a “sensitive point.”
So, what happens if the “sensitive point” becomes a stumbling block and the legislation needed to raise the debt ceiling does not get completed? In regard to financial markets, volatility would significantly increase. While this increase in volatility would likely lead to lower stock prices, bond prices could actually rise as investors migrate assets into U.S. Treasuries. This sounds very counterintuitive, buying sovereign debt, from the country that just went into technical default, but Treasuries are still perceived to be extremely high quality and many investors would perceive that a default would prove to be a short-lived event.
If the scenario described above is indeed the one that plays out, enhanced equity market volatility may also prove to be short-lived as lower interest rates would make valuations in the stock market more attractive.
It is important to remember that the U.S. has addressed the debt ceiling may times. In fact, according to the U.S. Treasury, Congress has taken action on the debt ceiling 78 times since 1960. With some of these situations the debt ceiling was increased, in others it was temporarily extended, or the definition of the debt limit was revised.
The most likely outcome is that an agreement is reached by the negotiators to raise the debt ceiling. And it will be done so in a way that allows the resulting legislation to pass both houses of Congress and be signed into law by the president. Given that much of the output from political news sources is already migrating to next year’s elections, neither party wants to be tarnished as being responsible for any economic hardship caused by the failure to address the debt ceiling in a timely manner.
The Investment Team at BTC Capital will continue to monitor the situation closely and take any actions deemed appropriate in accordance with the tenets of our investment philosophy.
Sources: BTC Capital Management, Axios
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