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U.S. Debt Ceiling Showdown: What You Need to Know

As the debt ceiling deadline approaches, we expect market volatility to intensify amid protracted political sparring.

05/12/2023

Key Takeaways

The U.S. government risks defaulting on its debt if Congress fails to raise the Treasury’s borrowing limit.

Though we think default is unlikely, the impacts across the global economy and financial markets would be profound.

Don't let debt ceiling worries derail your plans but ensure your long-term investment strategy aligns with your goals and tolerance for risk.

Update to Our February 28, 2023 Article

In early May, U.S. Treasury Secretary Janet Yellen advised Congress the U.S. government may breach its debt ceiling by June 1. The notification came just days after the U.S. House of Representatives narrowly approved a Republican plan to raise the $31.4 debt ceiling.

The House plan included spending cuts to the federal budget and the bill appears to have little chance of approval in the U.S. Senate. Moreover, President Biden repeatedly has said he will refuse to consider any legislation that requires spending cuts as a condition for raising the limit.

On May 9, Biden and congressional leaders met face-to-face for the first time for talks to resolve the deadlock. Though the session did not produce a deal, participants agreed further meetings and daily staff discussions to help work out a deal.

Biden said he has not ruled out invoking the 14th Amendment to the U.S. Constitution in an effort to declare the debt limit unconstitutional. A section of the amendment states that the validity of the country’s debt “shall not be questioned.” Such a maneuver by the White House would almost certainly spur litigation.

In the meantime, yields on short-term U.S. Treasury debt rose (prices fell) as investors steered away from government bonds that could face repayment delays in the case of a federal default.

How Could the Debt Ceiling Fight Affect My Portfolio?

  • Expect more stock market volatility.

  • Quality remains important as investors seek to own securities they believe can withstand economic and market turbulence.

  • Continued volatility is likely in the short-term fixed income instrument market with the potential for uncertainty to spread to broader markets.

  • Demand for longer-dated Treasuries could rise due to expectations they might be harmed less in a default scenario.

  • Higher borrowing costs will be a drag on corporate profits.

Published February 28, 2023

In September 2013, a Barron’s cover story headlined “Budget Disaster” warned that “our children could face an economic calamity as bad as the Great Depression” if the U.S. government failed to cut its long-term spending.

A decade later, the national debt has doubled to nearly $31.4 trillion.1 And, the portion of this debt owed to the public — individual investors, financial institutions and foreign governments that lend money to the government — has increased to 95% of U.S. gross domestic product. In other words, the amount of money the government owes to others essentially equals the size of the entire U.S. economy.2

As of mid-January, the U.S. Treasury needed more money to pay its current bills than federal law allows. So, raising the government’s debt ceiling — the limitation imposed by Congress on how much money the government can borrow — has taken center stage in U.S. politics.

Failure to raise the debt ceiling risks a government default on its debt obligations, with potentially dire financial and economic consequences for all of us.

What’s Happening With the Debt Ceiling?

On January 19, Treasury Secretary Janet Yellen sent a letter to Congress explaining that the government had reached its current debt limit, so the Treasury would take “extraordinary measures” to ensure it could keep making required payments to its public creditors.

These measures should allow the Treasury to continue meeting U.S. debt payments through early June. Even so, Yellen urged Congress to “act promptly to protect the full faith and credit of the United States.” But swift congressional action is no simple task — the debt ceiling has prompted intense political fights in recent years. And the longer such conflicts persist, the more they can rattle financial markets and investors.

The debt ceiling establishes the maximum limit on the U.S. Treasury’s outstanding debt.

The debt limit routinely gets increased for the Treasury to keep issuing bonds to finance previously authorized government outlays. Since 1960, Congress has raised the debt ceiling 78 times, including 20 times since 2001.3

It’s important to note that raising the debt ceiling doesn’t authorize new government spending. Only Congress can do that through its annual budget process. Increasing the debt limit only affects the ability to pay debts the government has already incurred — including promises bound by law to fund Social Security and Medicare.

In recent years, increasing the debt limit has ignited partisan bickering, leading to congressional standoffs that pushed the Treasury closer to exceeding its borrowing capability. These fights have had serious consequences. For example, in 2011, credit rating agency Standard & Poor’s downgraded the AAA rating that it had given the U.S. government for 70 years to AA+, a rating S&P still maintains.4

Since then, Congress has raised the debt ceiling six times. And each time, Congress has waited until a few weeks or even days before the existing ceiling’s statutory deadline before raising it.

Figure 1 | The Federal Debt and Debt Limit Have Risen Sharply in the Last 20 Years

Data from 9/30/1980 – 9/30/2022. Source: Fiscaldata.

What’s the Fallout From Debt Limit Political Fights?

The political acrimony surrounding the debt ceiling comes with a price tag. The periods immediately preceding the ceiling deadline have increasingly caused investor anxiety, historically pushing stock and bond prices lower.

One analysis found that federal lawmakers’ 2011 debt limit fight pushed borrowing costs for the Treasury up $1.3 billion.5 Another assessment concluded that the 2013 debt ceiling battle cost the U.S. economy $180 billion in lost output and reduced job creation by 1.2 million.6

Policy analysts worry that the current composition of Congress — a Republican-led House of Representatives and a Democrat-led Senate, both by narrow margins — could further complicate the negotiations needed to push the debt ceiling higher.

A faction of House Republicans appears set to demand concrete cuts to future spending for specific entitlement programs to reduce the government’s current annual budget deficits.

Meanwhile, House Democrats and President Joe Biden have pledged no reductions for Social Security or Medicare, meaning any cuts to future spending would have to come from the one-third of the federal budget consisting of discretionary expenditures, such as defense.7 The Biden administration has also said Congress should lift the ceiling with no conditions attached.

Yet to fully balance its budget and thereby avoid the need to issue new debt to cover expenditures, the government would require annual tax increases and spending cuts totaling $1.5 trillion — or about a quarter of its total spending in fiscal 2022.8

Even in the highly improbable event that Congress and Biden agreed to such measures, Congress would still need to raise the debt ceiling sometime before the end of the government’s fiscal year on September 30.

How Could a U.S. Debt Default Affect You?

A default would be unprecedented with global implications. The world’s leading economy, the issuer of the world’s primary currency and perceived “safest bonds, has never failed to meet its payment obligations.

A 2021 Bipartisan Policy Center analysis found that if the Treasury ran out of cash, it wouldn’t be able to meet about 40% of its payments due in the several weeks that followed.9 Retirees likely wouldn’t receive Social Security checks and members of the U.S. military and federal employees ranging from postal carriers to air traffic controllers might not get paid. Food assistance payments and checks for government and veterans’ pensions could halt.

Failing to extend the debt ceiling would put military and government employee paychecks at risk along with Social Security and government food assistance.

If a default occurs, credit rating agency Moody’s foresees an ensuing “cataclysmic” U.S. economic downturn comparable to the 2008-09 global financial crisis. The economy, Moody’s warns, would lose an estimated 6 million jobs, almost tripling the unemployment rate to 9%, and household wealth would plummet by $15 trillion with a third of the nation’s stock market value evaporating.10

In an economy already experiencing rising interest rates from the Federal Reserve’s (Fed’s) efforts to reduce inflation, borrowing costs for consumer loans — ranging from mortgages to credit cards — would rise even higher. Corporations would also face higher borrowing costs.

Even if financial markets and the economy eventually recovered, a default would have one long-lasting and damaging impact: Investors would no longer consider U.S. debt “risk-free” as they had for the past century. This would inherently push the federal government’s borrowing costs up permanently, making it even more difficult to service its existing debt.11

Should Investors Change Their Portfolios Due to the Debt Ceiling Fight?

The short answer to that question is we don't think so. The doomsday scenario remains just that — a scenario. And we think it’s an unlikely one. However, history shows that even if Congress avoids a default, waiting until the last minute to raise the debt ceiling would create mounting distress for financial markets as the clock ticks closer.

As we mentioned in our Investment Outlook, 2023 was setting up to be an unsettling year, even without a political tangle over the debt ceiling. With recession worries rising, economic news or central bank activity could trigger volatility. Geopolitical tension is also high, so there’s always the chance that unexpected events could upset the capital markets.

Considering the cumulative impacts of the Fed’s aggressive rate hiking, rampant inflation, supply chain disruptions and rising interest rates, we believe a recession is likely this year.

We recently updated our macro outlook to provide perspective on how asset classes could fare in a recessionary environment. Quality is a common theme for stock and bond portfolios as investors seek to own securities that they believe could withstand economic and market turbulence.

In the meantime, consider this another opportunity to review whether your diversified portfolio aligns with your objectives and your risk tolerance. If you haven’t done so lately, it may be time to rebalance your portfolio. Confirm that market activity hasn’t created unintended over- or underweights in asset classes or regions that have increased your risk.

As always, maintain your discipline when emotions run high and make decisions based on a carefully considered long-term investment strategy.

Author
Victor Zhang

Chief Investment Officer

Senior Vice President

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Jason Lange, “U.S. lawmakers preparing plan to avert debt-ceiling crisis,” Reuters, January 22, 2022.

Data as of 12/22/2022. Federal Reserve Bank of St. Louis, “Federal Debt Held by the Public as Percent of Gross Domestic Product.”

Leonard Burman and William G. Gale, “7 things to know about the debt limit,” Brookings, January 19, 2023.

Damian Paletta and Matt Phillips, “S&P Strips U.S. of Top Credit Rating,” Wall Street Journal, August 6, 2011.

Sage Belz, Sophia Campbell, Lorae Stojanovovic, and David Wessel, “What is the federal debt ceiling?” Brookings, updated in January 2023.

Mark Zandi and Bernard Yaros, “Playing a Dangerous Game With the Debt Limit,” Moody’s Analytics, September 21, 2021.

Tal Axelrod, “Biden and Republicans seem set for debt ceiling fight, reviving fraught political battles of years past,” ABC News, January 19, 2023; Jim Tankersley and Alan Rappeport, “America Hit Its Debt Limit, Setting Up Bitter Fiscal Fight,” New York Times, January 19, 2023.

Congressional Budget Office, “Monthly Budget Review: Summary for Fiscal Year 2022,” November 8, 2022; Burman and Gale, “7 things to know.”

Bipartisan Policy Center, “Debt Limit Analysis,” September 24, 2021.

Zandi and Yaros, “Playing a Dangerous Game.”

Reuters, “Explainer: A looming U.S. debt ceiling fight is starting to worry investors,” January 18, 2023.

Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

Diversification does not assure a profit nor does it protect against loss of principal.

Credit letter ratings indicate the credit worthiness of the underlying bonds in the portfolio and generally range from AAA (highest) to D (lowest).