Chris Kamykowski, CFA®, CFP® – Head of Investment Strategy and Research
Rich McDonald, MBA – Head of Portfolio Management and Fixed Income
Back in January, we wrote about the extraordinary measures being undertaken by the US Treasury to allow for payment of government bills. While newsworthy, this action had been taken many times before so it was not exactly unusual. At the same time, we noted that Secretary of the Treasury, Janet Yellen, had warned these measures would likely only be effective until early June, giving Congress ample time to solve for the coming debt ceiling issue. We noted: “Clearly, the closer we get to June without a resolution, the more perilous the situation could become.”
Today we see a “perilous” moment on the horizon as negotiations have finally started in earnest as markets stare down a shifting X date; this date represents when the US Treasury can no longer use its extraordinary measures to pay all expenses. With 2022 personal tax receipts coming in well lower than last year, the US Treasury faces a sooner-than-expected date by which it will require additional funding to cover bills. The Treasury department has estimated that the government will run out of money to pay its bills as early as June 1, 2023. If Congress does not raise the debt ceiling by then, the government runs the risk of a default on its debt, which would likely create significant market volatility. This doesn’t mean that the U.S. is out of money, but rather it must make choices on how to use the money it has for bills due. A situation where it prioritizes payments is often referred to as a technical default as they could choose to make all debt payments (Treasury bonds) and make partial payments on other obligations like Medicare, Social Security or national defense. To be sure, Janet Yellen has made statements that there are no plans to prioritize certain payments over others, currently.
Politics are front and center, for better or worse. Many may loathe politicians playing with fire such as the US’s credit status, but they are the ones elected who must come together to negotiate and resolve the issue. The positions currently between Republicans and Democrats on how best to deal with the debt ceiling are clearly disparate and not made easier by very vocal constituencies in both parties. Starting positions for each party are noted below:
Republicans’ key desires are:
- Government spending reductions and cap on annual increase to federal discretionary spending
- Work requirements for government aid recipients.
- Accountability for future changes to the debt ceiling
- Recover unused COVID relief funds from various bills enacted from 2020-2022.
- Eliminate student loan relief efforts by the White House
Democrats on the other hand are seeking:
- Unconditional increase in debt ceiling
- A bipartisan agreement
- A long-term debt ceiling increase
Something will have to give between the two parties’ demands as it relates to a debt ceiling deal, and much political maneuvering will be required of both parties to secure enough votes to pass in both the House of Representatives and Senate. Negotiations between senior leadership in both parties and the White House have started. The negotiations are currently a central story for the market as it assesses any comments coming from those involved with the negotiations and those privy to them. Both parties have expressed support in avoiding a default on US Treasury debt which provides a degree of confidence that something will get done in time to avoid a default. Events could move very swiftly as discussions move forward, and for good reason: some market commentators have noted that the procedural elements of drafting, reviewing and passing an agreement is facing an ever-tightening period of time, forcing parties involved to move with deliberate intention. As of mid-day Friday, May 19th, there is word of potential concessions between the two sides to strike an agreement next week, although an impasse has led to a pause in the negotiations.
For all the talk about the debt-ceiling and concern over a potential default by the US on its debt, markets have been surprisingly calm. The S&P 500 just reached a new high for the year and Treasury rates have been generally range-bound, floating in a +/- 0.30% range the last month. That said, things could change rapidly if a resolution is not seen as probable by the markets or time seemingly runs out. In 2011, the S&P 500 fell sharply as negotiations drew closer to the X Date and only bottomed after a resolution was enacted before beginning a recovery over the rest of the year. An on-going European debt crisis was also jostling markets at the same time, providing ample catalysts for a risk-off move in the markets. Today, tightening monetary policy and concerns over a looming recession presents additional circumstances the market must navigate alongside the debt ceiling concern.
As we noted in our piece earlier in the year, any failure by the U.S. to make interest payments on time could cause havoc in the financial markets, as markets prefer certainty to uncertainty; when we are talking about THE risk-free rate that underpins global financial markets, this is even more apparent. No one – Democrat or Republican – wants a default given the high stakes and serious consequences of such an event; 2024 elections are on the horizon. Investors can expect to see some increased volatility given the situation but should remember that markets are very efficient at processing news on both the positive and negative ends. To that end, our recommendation through this period of political and fiscal uncertainty is that is it important to control what you can and maintain a balanced portfolio in line with your goals. Hopefully, elected officials will take heed of the fast-approaching X date and work together toward a resolution that avoids unnecessary impact to the soundness of US credit.
Definitions
The Treasury General Account is the U.S. government’s operating account that is maintained by designated depositaries, primarily Federal Reserve Banks and their branches, to handle daily public money transactions.
The S&P 500 Index is a free-float capitalization-weighted index of the prices of approximately 500 large-cap common stocks actively traded in the United States.
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