Economic & Market Commentary | January 27, 2023
Once again, there is potential gridlock in Washington. Representative Kevin McCarthy (CA-R) was finally elected Speaker of the US House of Representatives following numerous failed votes and countless negotiations with members of his own party. McCarthy made several concessions to fiscal conservatives, including a promise to not pass a debt-ceiling increase without significant spending curbs.1 This request from conservatives is not without purpose as the US Government is due to hit the debt ceiling in mid-summer 2023.
The debt ceiling - not to be confused with the annual Government spending deficit – is the maximum amount the US Government is allowed to borrow to meet its financial obligations. Currently, the US debt ceiling is $31.4 trillion. Treasury Secretary Yellen put Congress on notice last week that the federal government would only be able to pay its bills through June of this year.2
So, the question is – what happens if the debt ceiling isn’t raised, and the US Government can’t pay its bills? While there has never been a time where Congress failed to raise the debt ceiling, were they not to, it would lead the US Government to default on its obligations. If this Congress did fail to lift the ceiling, it could eventually lead to money market funds freezing up, delays in treasury bond payments, and other government programs not covered by revenue such as social programs, defense spending and government employment salaries coming to a halt. As a result, the Treasury has begun using extraordinary measures to make sure the US can pay its obligations until “X-date” – the day which the debt ceiling would have to be raised.3
Lifting the debt ceiling is certainly significant, but as we mentioned above, it has been fairly common in our nation’s history. The debt ceiling was created in 1917 by the passing of the Second Liberty Bond Act and was raised 90 times in the 20th century alone – those in recent memory include: 18 times under President Reagan, 8 times under President Clinton (most notably, 1995), seven times under President G.W. Bush and five times under President Obama.
In 1995, newly elected Speaker of the House, Newt Gingrich (GA-R), was pushing first term President Clinton (D) into signing into law sweeping entitlement cuts and a balanced budget. This political chess match went on for over a year and included government shutdowns but no default. While some believe the Republican congress was always bluffing and never intended to force the US Government into default – the political debate was tense with then President Clinton accusing the Republicans of “economic blackmail”. Ultimately, the two sides agreed to raise the debt ceiling and passed portions of the Contract with America bill. It’s worth noting that they came to this arrangement largely due to Moody’s warning that it was considering downgrading the credit rating on US Treasury bonds.4 5
In 2011, there were very similar undertones to what is taking place today. In January 2011, the Republicans took control of the House chamber while President Obama (D) was midway through his first term in office. The Tea Party faction of the Republican party was gaining steam and planned to force spending cuts in exchange for agreeing to raise the debt ceiling. While a compromise was ultimately reached two days before the “X-date” – the impact was still felt in the financial markets. This was largely due to the credit rating agency, Standard & Poor’s, decision to strip the US of its coveted AAA rating. In the lead up to the debt ceiling vote and the months following the US debt downgrade, the S&P 500 fell as much as 12% by October 2011. However, by the end of 2011 the S&P 500 had fully recovered finishing the year flat while treasuries rallied, leading to their best year since 2008. In the two years following, the S&P 500 went on to gain 15.89% in 2012 and 32.15% in 2013 respectively.6 7
*Index returns are provided gross of fees and do not reflect actual client performance. Past market performance is not a guarantee of future results.
Source: Return data provided by The Balance
While we can’t use the past to predict what will occur in the future – it can serve as a guide. The situation the US government finds itself in today is not unlike that of a decade ago. We have a first term Democrat President and a newly elected Republican Congress with a few Republican holdouts trying to negotiate spending cuts in exchange for raising the debt ceiling as was the case in both 1995 and 2011. Since the imposition of the debt ceiling, Congress has always come to an agreement to raise the debt ceiling, allowing the US to continue to pay its bills.
It remains to be seen when and if this Congress will come to an agreement, and we will stay attuned to the negotiations and the eventual outcome and their effects on markets and your portfolio. These negotiations do not change our overall goal of seeking to construct well-conceived, diversified, and properly monitored portfolios that perform in up markets and weather the down markets.
Each of our clients has a different time horizon and investment objective. We are always happy to discuss your situation in more detail, so please do not hesitate to contact us with your questions or comments anytime. This article is not a substitute for individualized advice. Please extend an open invitation to family members, friend and colleagues who might appreciate the perspective that we offer.
1 House Majority Leader Scalise sidesteps thorny question, CNBC 1/10/2023
2Yellen Says US Will Hit the Debt Limit Soon. This Is What’s at Stake, Barron’s 1/13/2023
3How to Invest as a Debt Ceiling Crisis Looms, New York Times 1/19/2023
4The US has reached its debt limit. What comes next is predictable, CNN , 1/19/2023
5How Clinton Handles His Debt Ceiling Crisis Better Than Obama, New Republic 8/1/2011
6Stocks Finish Rocky Year Like It Never Happened, CNN Money , 12/30/2011
7A Debt-Ceiling Crisis Looms. An Example from History to Heed, Barrons 1/21/2023
President Debt Limit Graph, CNBC via US Treasury
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