[ad_1]
If we had to guess, your social feeds and inboxes have been flooded with hysterical headlines about America hitting its debt ceiling—a limit on the nation’s borrowing that, if not addressed, risks considerable consequences to all Americans, and indeed, the entire global economy.
Today, we’re going to focus on one specific aspect of the current debt-ceiling crisis: That is, what it could mean for investors big and small, young and old. While this is very much a crisis that will be solved (or not) in Washington, D.C., we’re not here to talk about politics—we’re here to talk about personal finance.
With the help of a number of financial and investment experts, we’ll first discuss what the debt-ceiling crisis actually is, and then we’ll talk about the potential ripple effects it could have on the U.S. economy and your portfolio.
The Tea: First things first: Do you know what the debt ceiling is?
Let’s say you get a large, unexpected bill in the mail, and the money you’ve already brought in for the month won’t cover the tab. Chances are, you’ll take out a loan to pay that bill.
YATI Tip: Don’t get caught financially off-guard. Use our free Excel template to make a budget.
Well, that’s not just for people: The U.S. government does the same thing. But unlike the rest of us, the government has a Congressionally mandated cap on how much it can borrow.
That’s the debt ceiling.
When government spending hits that debt ceiling, like it did on Jan. 19, the gears don’t just grind to a halt. The U.S. can still keep paying some bills through so-called extraordinary measures.
“These include shifting money around different government accounts, robbing Peter to pay Paul, to fill the gap until more borrowing is allowed to catch up,” says Brad McMillan, Chief Investment Officer for Commonwealth Financial Network, a Registered Investment Adviser and independent broker/dealer. “Examples include suspending retirement contributions for government workers and repurposing other accounts normally used for things like stabilizing the currency.”
The purpose of this isn’t just to pay the bills in the short-term, however. It’s meant to give Congress more time to allow the U.S. to borrow more—by raising the debt ceiling, which has proven surprisingly elastic over time.
“Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit,” says the U.S. Treasury. (Both major political parties do this, by the way: The Treasury notes that this has happened 49 times under Republican presidents and 29 times under Democratic presidents.)
How long can the Treasury hold out?
“[Treasury Secretary Janet] Yellen noted that the Treasury has initiated special procedures to allow the government to pay its bills and floated June 2023 as the ultimate date for when the U.S. government may run out of cash,” says Daniel Berkowitz, senior investment officer for investment manager Prudent Management Associates.
The Take: If the Treasury runs out of ways to kick the can down the road, there are very real, and very unpleasant, consequences across the board.
We keep talking about the Treasury being able to “pay its bills.” Well, at a certain point—again, Yellen points to June 2023—it would no longer be able to make good on at least some of those bills. And the nature of those bills have two downstream implications for investors:
Economic Growth
Among the government obligations that could be delayed include Social Security payments, federal employees’ salaries and veteran benefits. Those payments aren’t exactly hoarded away—they’re spent and funneled right back into the economy.
“Limits on, for example, Social Security payments would severely hurt both economic demand and confidence,” McMillan says. “While that would likely be the last thing cut, if possible, other cuts would also hurt growth and confidence. We saw exactly this in prior shutdowns, and the damage was real.”
Treasury Default
But the more troublesome bills that could go unpaid are bond payments.
YATI Tip: Don’t put all your eggs in one basket. Diversify with these mutual funds.
A debt issuer goes into default when they fail to pay interest or principal to a bondholder on time. Currently, U.S. Treasury bonds sport one of the highest bond ratings on earth, implying that there’s extremely low risk of default. Because there’s so little risk, the U.S. can pay a low interest rate (compared to other debt issuers) and still generate demand for its bonds.
“One of the sacrosanct assumptions underlying modern investing is that U.S. Treasury securities bear no credit risk,” says Steve Sosnick, Chief Strategist at Interactive Brokers. “The U.S. government has the means and methodology to pay its debts, but the debt limit can constrain that process in the short term. Even a slight hiccup in our debt payments could cause investors to question whether U.S. debt requires a higher risk premium.”
The Congressional Budget Office (CBO) already expects the national debt to keep growing for the next decade. “Interest costs are expected to become a larger percentage of the federal budget and net interest as a percentage of GDP is projected to nearly double by 2030, which may lead to a potential reduction in funding for other government initiatives and/or higher taxes in the future,” say Glenmede’s Jason Pride, Chief Investment Officer of Private Wealth, and Michael Reynolds, President of Investment Strategy.
A hike in interest rates could exacerbate this issue, costing America billions of dollars more over time.
“But I don’t own bonds,” you say?
Bond prices and bond yields go in opposite directions, so if Treasury yields go higher, that means Treasury prices are going lower—which means investors are losing money in one of the supposedly safest investments on earth.
That’s not happy news for riskier investments, such as stocks.
“We have noted before that if safe assets get clobbered, risk assets don’t stand a chance,” Sosnick says. “If a debt-ceiling fiasco causes global investors to re-rate U.S. Treasuries, that will spill into assets of all types in highly unpredictable ways.”
How Likely Is This Worst-Case Scenario?
If there is any good news, it’s that we’ve been here before—dozens of times. As mentioned before, the debt ceiling has been lifted 78 times in the past. And most of the experts we’ve talked to expect us to get to No. 79 before the clock strikes midnight on the U.S. Treasury.
But most experts also expect fireworks.
“We expect Republicans to want spending cuts in return for lifting the debt ceiling. We expect Democrats to rebuff those efforts. So, it’s probably going to be a volatile process, and we could go to the brink as we did in 2011,” say Courtney Rosenberger, Washington Research Strategist at institutional broker-dealer Strategas, and Ross Mayfield, Investment Strategy Analyst at Baird Private Wealth Management. “That means that we’ll have both heightened political volatility and market volatility as we get closer to that debt ceiling deadline.”
Of course, it wouldn’t necessarily take a full-on default for U.S. Treasuries to take a hit. American debt has been downgraded for less. More than a decade ago, a particularly close brush with default (that the U.S. ended up avoiding) was enough for one ratings agency to knock American debt down a rung. “It’s been some time,” Berkowitz says, “but it’s not impossible for history to repeat itself.”
For now? Be watchful—the worst-case scenario of failing to lift the debt ceiling in time would indeed be hazardous for investors. But don’t worry. At least not yet.
YATI Tip: Keep up-to-date on the market with these stock news apps and sites.
“We have months to go from here to there, during which there are enormous incentives to cut a deal,” McMillan says. “And even if a deal is not cut? There are other, non-default options.”
“Markets have largely learned to look through the process. Could we see some volatility? Quite possibly. But we are not really seeing it yet, suggesting markets expect the same old movie ending again.”
Riley & Kyle
Young & The Invested
Like what you’re reading? Get our weekly financial insights and updates delivered to your inbox every Saturday morning by signing up for The Weekend Tea today!
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
[ad_2]
Image and article originally from www.nasdaq.com. Read the original article here.