Every so often, or as some people suggest, too often, the equity market faces the prospect that the U.S. will lose the ability to pay its bills as a result of the U.S. not being able to borrow.
Numerous times over many years, Congress has established what has become known as the debt ceiling. However, unlike every other ceiling known to man, since 1944 elected officials found a way to push through this ceiling 104 times—54 times while a Republican occupied the White House with Democratic presidents overseeing the rest. Most recently, during President Donald Trump’s term, the debt limit was raised twice— by $1.7 trillion in 2017 and by $2.2 trillion in 2019. Interestingly, the debt ceiling was suspended in 2015, 2018, and 2019, as Congress agreed to limit discretionary spending on both defense and nondefense items.
The frequency of increasing the federal borrowing limit has happened so often that individuals fail to recognize the consequences of Congress not acting to adjust the limit. The most significant of these would be to stop all government functions. Treasury Secretary Janet Yellen recently urged Congress to reach an agreement to raise the debt ceiling soon, saying a “failure” to do so “would cause irreparable harm to the U.S. economy and the livelihoods of all Americans.” Yellen warned the default on U.S. debt payments could come as early as mid-September, while the Congressional Budget Office warned the Treasury’s money could run out sometime in October or November if Congress does not raise the debt ceiling.
Similar warnings have accompanied virtually every previous instance when Congress faced the reality of possibly losing the ability to spend money. The potential consequences were not lost on investors in 2011 and 2013.
The notably contentious battle in 2011 about government spending eventually led to passage of the Budget Control Act of 2011 and the mid-year approval of an increased debt authorization. The equity market held up well early in 2011, which suggested that a resolution to the debt issue would have allowed the market to resume the strong upturn it began in the third quarter of 2010. Instead, on August 8, 2011, the market fell sharply following the downgrade of U.S. sovereign debt from AAA to AA+; the first-ever downgrade of U.S. debt.
It was not long before the debt ceiling again was an issue. In 2013, the United States reached the debt ceiling of $16.394 trillion that had been enacted following the debt ceiling crisis of 2011. The debt ceiling did not extract a toll from the market. The S&P 500 spent the year moving steadily higher as Congress and the White House used various techniques multiple times to fund the government.
Yellen’s warning about the consequences of failing to raise the debt ceiling should not be cast aside as merely political posturing. At the same time, the threat of dire consequences has accompanied numerous debt ceiling debates previously before agreements were reached.
Nonetheless, in a letter to House Speaker Nancy Pelosi, Yellen outlined “certain extraordinary measures to continue to finance the government on a temporary basis.” She added, “Our estimates of the period of time that extraordinary measures will last have been refined in recent weeks, although they continue to be subject to considerable uncertainty due to the normal challenges of forecasting the payments and receipts of the U.S. government, including the uncertainty in the level of corporate and individual taxes due September 15.”
As the Treasury Secretary suggested, uncertainty over how long temporary measures can be used to fund the government could generate increased volatility. In our view based on the long history of this issue, the reality of failing to act eventually can lead to a resolution without creating lasting equity market damage.
For the time being, however, the current debt ceiling debate comes at a time when the market has a distinctly negative seasonal bias, which suggests that some near-term caution is appropriate until the current debt ceiling debate is resolved.
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