{"id":9384,"date":"2023-01-30T22:21:45","date_gmt":"2023-01-30T22:21:45","guid":{"rendered":"https:\/\/zacksim.com\/financial-professionals-insights\/?p=9384"},"modified":"2023-01-30T22:21:46","modified_gmt":"2023-01-30T22:21:46","slug":"what-will-a-debt-ceiling-standoff-mean-for-the-markets","status":"publish","type":"post","link":"https:\/\/zacksim.com\/financial-professionals-insights\/what-will-a-debt-ceiling-standoff-mean-for-the-markets\/","title":{"rendered":"What Will a Debt Ceiling Standoff Mean for the Markets?"},"content":{"rendered":"\n

Another year, another debt ceiling showdown.<\/p>\n\n\n\n

Some investors and readers may feel like it\u2019s Groundhog Day with headlines of \u201ccatastrophic\u201d consequences if the U.S. government fails to pay its bills. And let me be clear: I agree that failure to pay interest and\/or principal on Treasury bonds would have severe economic and market consequences.<\/p>\n\n\n\n

I just don\u2019t think the U.S. will get there.<\/p>\n\n\n\n

The debt limit was created in 1917 and has been raised over 100 times, with numerous instances where a political standoff made its fate unclear. Some would say the current political environment makes a negative outcome more likely with both parties dug into their respective positions \u2013 a fair point. But even the most extreme form of brinkmanship would not likely result in the U.S. defaulting on debt, which has never happened in history.1<\/sup><\/p>\n\n\n\n

One widely under-reported reason is that a debt default is unconstitutional, as per the Supreme Court\u2019s 1935 interpretation of the 14th<\/sup> Amendment\u2019s Public Debt Clause. \u201cThe validity of the public debt of the United States\u2026shall not be questioned,\u201d the Supreme Court wrote in a ruling, which has long been interpreted as meaning that default is simply not an option.2<\/sup><\/p>\n\n\n\n

But another source of confusion in the debt ceiling debate is: what constitutes a \u201cdefault?\u201d This is a point the media \u2013 and even Treasury Secretaries \u2013 often deliberately fail to explain clearly. <\/p>\n\n\n\n

In the media, there are obvious advantages to skipping the technical, granular, boring details of how the debt ceiling and bond principal and interest payments work. It\u2019s easier to just say that failing to raise the debt ceiling automatically triggers a default, which is not the case.<\/p>\n\n\n\n

As for government communications, the acting Treasury Secretary \u2013 in this case Janet Yellen \u2013 almost always resorts to conflating government obligations, like Social Security payments or government worker wages, with defaulting on U.S. debt. Just last week, Treasury Secretary Yellen said, \u201cA failure on the part of the United States to meet any obligation, whether it\u2019s to debtholders, to members of our military or Social Security recipients, is effectively a default<\/em>.\u201d Ms. Yellen had to use the word \u201ceffectively\u201d in her statement because the actual definition of default singularly means failing to pay interest or principal on U.S. Treasuries.<\/p>\n\n\n\n

Being late on\u2014or missing\u2014a Social Security payment or a child tax credit payment is not the same thing as missing a principal payment and\/or interest payment on a Treasury bond. The former is an unfortunate lapse in a government entitlement program; the latter is \u201cdefault\u201d in the true sense of the word.<\/p>\n\n\n\n

A little-known fact is that the last time the debt ceiling issue came to a head, in 2011, the Federal Reserve and Treasury officials privately made a plan to make on-time payments on Treasury debt while delaying payment on other government bills. A review of Fed transcripts at the time makes it clear that while the rhetoric almost always focuses on default \u2013 likely an attempt to influence public opinion and exert political pressure \u2013 behind the scenes government officials were ensuring a default would never happen. Markets understand this point. <\/p>\n\n\n\n

The actual risk of not raising the debt ceiling would be missing entitlement payments and payments to other government programs\u2014which, again, is not the same thing as defaulting on debt. <\/em>Missing entitlement payments is not good, and a lapse can weigh heavily on sentiment, credibility, and potential markets. But Congress\u2019s failure to act would not necessarily trigger an actual default or credit event in financial markets, as is often framed in the media. <\/p>\n\n\n\n

A natural follow-up question is, how can the Federal Reserve and U.S. Treasury keep making on-time principal and interest payments without a raised debt ceiling? <\/em>It happens in two ways. For bond principal <\/em>payments that come due, the U.S. Treasury is authorized to issue new debt to refinance a maturing bond\u2014no Congressional approval needed.<\/p>\n\n\n\n

For bond interest <\/em>payments due, the Treasury receives far more in monthly tax receipts than it owes in monthly interest payments. As of the end of fiscal 2022, interest payments due on U.S. Treasuries accounted for just 9.7% of total tax revenue. This is akin to making $10,000\/month in salary and having a $970\/month mortgage payment, which would of course be easily manageable.<\/p>\n\n\n\n

The U.S. Treasury Receives Enough in Paid Taxes (blue bars) to Cover Interest Payments on Debt (red bars)<\/strong><\/p>\n\n\n\n

\n
\"\"
Source: Federal Reserve Bank of St. Louis3<\/sup><\/em><\/strong><\/figcaption><\/figure>\n<\/figure>\n\n\n\n

Bottom Line for Investors<\/strong><\/p>\n\n\n\n

In my view, markets have seen enough debt ceiling standoffs \u2013 especially in recent years \u2013 to be able to price in some of the likely outcomes. According to the Treasury Department, there are enough funds available to pay all government obligations (Social Security, wages, etc.) and payments due to bondholders until June, even without the debt ceiling being raised. This runway may mean we\u2019ll have to spend months hearing about debt ceiling infighting in Congress, but it may also mean the actual threat of missing obligations is low assuming Congress can work out a deal in that time. For reasons explained above, it\u2019s these obligations that investors should weigh from a market\u2019s standpoint, not a default.<\/p>\n","protected":false},"excerpt":{"rendered":"

This isn’t the first time the U.S. government has faced a debt ceiling showdown\u2014here’s how investors should think about this one.<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[181,1],"tags":[],"class_list":["post-9384","post","type-post","status-publish","format-standard","hentry","category-financial-professionals","category-mitch-on-the-markets"],"acf":[],"_links":{"self":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts\/9384","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/comments?post=9384"}],"version-history":[{"count":2,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts\/9384\/revisions"}],"predecessor-version":[{"id":9387,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/posts\/9384\/revisions\/9387"}],"wp:attachment":[{"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/media?parent=9384"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/categories?post=9384"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/zacksim.com\/financial-professionals-insights\/wp-json\/wp\/v2\/tags?post=9384"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}