February 27, 2019
Craig Holke, Investment Strategy Analyst
Debt and Chickens
Following the recent government shutdown, the next major fiscal hurdle will be the upcoming federal debt ceiling limit suspension that expires on March 1, 2019.
- The implications of failing to raise the federal debt ceiling and potentially risking default are much more significant than a partial government shutdown. This is why we believe that the federal debt ceiling will be increased before extraordinary measures expire— just as it has been increased in the past.
- Although we consider it unlikely, any political standoff or delay in raising the debt ceiling (beyond May or June) could roil equity markets until a debt-ceiling deal is concluded.
- We already have started to see yields on Treasury bills that mature near the expected debt-ceiling deadline edge slightly higher. In the event of a standoff, fixed-income markets could suffer. U.S. interest rates could rise, negatively affecting most fixed-income securities. In such a risk-off scenario, the remaining perceived flight-to-quality bond havens (such as Japan and Germany) could benefit.
Next potential showdown?
Having recently experienced a record-setting 35-day federal government shutdown, we narrowly avoided a repeat this month. We may not have long to wait before the next fiscal conflict in Washington, D.C. Last year, as part of the Bipartisan Budget Act of 2018, Congress suspended the federal debt ceiling limit until March 1, 2019. The debt ceiling is an arbitrary limit on the amount of federal debt that can be issued by the U.S. Treasury. When the debt ceiling is reached, the federal government may no longer borrow to pay bills (e.g., salaries, benefits, interest, and principal). Reaching the debt ceiling limit does not necessarily trigger an immediate crisis. The Treasury Secretary has the authority to prioritize and postpone payments to extend the debt ceiling through “extraordinary measures.” This has provided a cushion ranging from weeks to months. We believe that the Treasury has the ability to manage through the hard debt ceiling spending limit until early summer.
How much Congress raises the debt ceiling limit determines the amount of time until Congress must address it in the future. By spending more than is taken in each year, the U.S. must continuously borrow more money— perpetually increasing the amount of federal debt. As we will discuss in the Fiscal policy section of this month’s report, most federal government spending is outside of the annual budget process. However, unless laws are changed, Congress does not have discretion over the amount that is spent on the largest portions of the federal budget—entitlements such as Social Security and Medicare. Given that much of annual federal spending falls outside of Congress’ annual budgetary discretion is, in our view, a main reason why the deficit and public debt continue to grow.
The recent change of control in the House of Representatives may increase the friction between Congress and the White House over a new debt ceiling, but we believe that the credit quality of the U.S. and global financial stability are too important to risk for domestic policy priorities. Ultimately, we expect that cooler heads will prevail and the debt ceiling will be raised before a default—even if the government does utilize extraordinary funding measures for a period of time.