There’s been lots of chatter in the news lately about the debt ceiling. While Congress has recently reached an agreement on the matter, many individuals haven't fully grasped the significance for themselves and their families.
In this blog, we aim to provide a comprehensive summary of recent market developments and outline the potential impact on your financial future. By delving into this topic, we can gain a clearer understanding of how it may affect our financial well-being and make informed decisions moving forward.
What is the Debt Ceiling?
The debt ceiling is the maximum amount of money that the U.S. government is allowed to borrow. When the debt ceiling is reached, the government can no longer borrow money to pay its bills, which could lead to a government shutdown or default on its debt. The ceiling is a legislative limit set by Congress on the amount of national debt that can be incurred by the U.S. Treasury.
On May 31st 2023, the debt ceiling bill passed by the House of Representatives would suspend the government’s borrowing limit until January 2025, ensuring the issue will not resurface before the next presidential election.
We should also be aware that there is a risk associated with what has just happened -- the treasury’s need to replenish cash. The ceiling left the treasury general account with $50 billion and a need to issue another $1.25 trillion in treasury bills for the rest of the year.
What’s the Importance of Raising the Debt Ceiling?
One of the biggest risks of raising the debt ceiling is the US Government’s credit rating under these circumstances. Fitch rating services in late May placed U.S. Treasury Debt on a negative credit watch. Meaning, that the loss of the AAA rating would have significant consequences. For example, the loss of the AAA rating in 2011 to AA+ made it more expensive for the United States to issue bonds (debt) in order to fund government operations.
Additionally, current holders of U.S. Tresasury bonds would experience delays in payments of their interest and return of principal (original investment), in other words, a default on their obligations. A default on the national debt would have a devastating impact on the U.S. economy and could lead to a recession.
The importance then of raising the debt ceiling is to avoid a default and maintain the full faith and credit of the U.S. Treasury and Government. To ensure the government can continue to function, they need to be able to borrow money to pay for its essential services, such as Social Security, Medicare, and the military.
What does all this mean for me and my family?
As a result of the raised debt ceiling, you can expect reduced market volatility which we saw with a return to a bull market off of October 2022 lows. That helps portfolios, savings and goal planning via increased confidence in the economy.
This also means that paychecks to millions of federal employees go out, you get your mail delivered in a timely fashion, medical bills can be paid, and federal aid money will still go to the states to help support the construction and building of highways and bridges. The list of benefits goes on.
Is there anything specific I need to do for my investment accounts if this happens again?
Because the debt ceiling has always been increased, it can be easy to think “Well I don’t need to worry about it until it becomes a real problem.” Wrong! The best approach would be to create an outcome that is based on the crisis being resolved.
It's important to remember that the debt ceiling crisis is a temporary event. Markets would eventually recover, and investments would regain their value. So, we recommend the following:
- Don't panic, sell: It's natural to want to sell your investments when the market is down. And that is usually the worst time to do so as you'll lock in your losses. Instead, try to stay calm and ride out the storm.
- If you rode out the 2008-2009 financial crisis by not selling you understand this when you look at your friends, family, or peers that did. If you invested more during that time, you even better understand owning great quality at lower prices. Invest defensively.
- Adjust your asset allocation, consider dollar cost averaging and stay informed and keep your emotions in check. Intermediate and longer-term bonds would likely out-perform shorter term bonds.
In conclusion, it’s important to remember there are still significant headwinds to navigate, such as inflation, interest rates, output growth slowing in response to a sharp rise in interest rates during 2022, and the potential for a recession and rising unemployment due to it.
The deal does little actually to change the direction of Federal spending or the economy but the potential financial disaster by a government shutdown is averted for now.
However, in the future, economists believe a federal government unable to make interest payments on the debt in a timely manner would cause stock and bond markets to plummet, millions of jobs to be lost, and touch off a recession at least on the scale of the 2007-2009 downturn.
The debate over whether we should even have a budget ceiling may very well be something we see stumped on in this next election cycle. To learn more or speak directly with one of our wealth advisors, please contact andermanwealth.com.
Wall Street Journal
The Congressional Budget Office
Council on Foreign Relations
The Brookings Institute
Investments are subject to market risks including the potential loss of principal invested. Asset allocation does not assure or guarantee better performance and cannot eliminate the risk of investment losses. Dollar-cost averaging does not assure a profit and does not protect against loss in declining markets. Such a plan involves continuous investment in securities regardless of the fluctuation of price levels of such securities. An investor should consider his or her financial ability to continue his or her purchases through periods of low-price levels.