Where We Are Now?
Following a week of headlines of passing meetings between Speaker McCarthy and President Biden on the state of debt ceiling negotiations and the Memorial Day Weekend we were greeted with news of a tentative deal on the debt ceiling. The broad strokes of the deal included a two-year government spending budget in exchange for lifting the ceiling until after the 2024 election.
If you recall our government reached the current debt ceiling limit in January of this year of $31.4 trillion1. Without an increase and the ability to issue more debt the government must figure out how to pay the bills with only tax revenues.
For the last two weeks the closest we were to a resolution were “productive” talks between the parties, with more talks predicted. The sticking points between the two parties focused on spending cuts and other elements around unspent Covid funds.
Although some members of Congress have publicly come out against it, leadership must convince Congress to pass it by June 5th to avoid defaulting.
When Will The Government Run Out of Money?
After reaching the limit, the US Treasury began to rely on “extraordinary measures” to continue to meet the government’s obligations. In January, Treasury Secretary Yellen, in a letter to Congress indicated that she believed these measures would be exhausted before early June. Much of the reported deadlines had focused on June 1st as the “X date”. Some members of Congress believe as does Secretary Yellen that the date is now closer to June 5th to get a deal done.
Will the Treasury Default?
Although it appears to be less and less likely the US will default, it’s not impossible until the bill is passed and signed by the President. The 2021 agreement to raise the limit by $2.5 trillion dollars was increased just a day before potential default. So, it’s still very possible this saga continues if members of the House Rules Committee were to oppose the parameters under which the bill would be considered. Alternatively, if enough House or Senate members were to also oppose it, that would be a significant setback.
How Have Markets Responded?
Since the beginning of the month, equity markets have been relatively calm and taking it in stride. US large cap stocks as measured by the S&P 500 Index are up about 1.07% and small cap stocks as measured by the Russell 2000 Index are up about 0.35% so far, this month2.
The biggest move in response associated with the debt ceiling can be found in yields on the very short end of the Treasury yield curve. For example, one-month US Treasuries yields have climbed from about 4.5% to 5.3% since the beginning of the month. At one point yields on one-month Treasuries even crossed the 6% threshold.
It remains to be seen what future impact this debt ceiling saga will have on future borrowing costs for the government. Each time the government teeters on the balance of a default with last minute deals, it only calls into question the reputation of the US government as a riskless borrower. Who knows? Will this be seared into the memory of investors? Or will it fade away as investors focus on the next headline risk?
In the aftermath of this saga, the US is still enduring inflation and future changes in interest rate policy. Given the response of capital markets, this is probably not the time to make significant wholesale portfolio changes to try and time current events. Markets have priced in a myriad of potential outcomes and staying with your long-term investment plan can help you see beyond today’s turmoil.
1 Source: Congressional Budget Office https://www.cbo.gov/publication/58945
2 Source: Y-charts
by Bryan Hutto, Vice President, Senior Investment Officer