Key takeaways

  • The U.S. government’s authorization to borrow money is set to expire in 2023.

  • A change in control of the House of Representatives raises questions about the path forward to raise the debt ceiling.

  • That could prove disruptive to markets this year.

An issue frequently confronting the U.S. Congress is the need to raise the debt ceiling limit, which allows the federal government to continue to borrow to pay its bills. At times, this turns into a contentious political dispute, often because some members of Congress seek to use the debt ceiling requirements as leverage to pursue other policy goals.

The federal government’s authority to issue new debt expired on January 19, 2023. At that time, the U.S. Department of the Treasury began implementing so-called “extraordinary measures” to prevent a default on paying the government’s bills.

 

What is the debt ceiling?

The federal debt is the total amount of money the government owes for spending on everything from Social Security and Medicare to defense programs and other types of domestic and overseas expenditures. The debt limit set by Congress represents the funds that the U.S. Treasury is authorized to raise through debt security offerings to pay the government’s operating costs.

Although it’s a somewhat arcane procedure, raising the debt ceiling allows the U.S. Treasury to continue debt issuance to pay for Congressionally-approved federal government spending. Treasury Secretary Janet Yellen noted in 2021 that, “Increasing or suspending the debt limit does not authorize new spending commitments or cost taxpayers money. It simply allows the government to finance existing legal obligations that Congresses and Presidents of both parties have made in the past.”

The need for such Congressional action has occurred nearly one hundred times since World War II. Most often, passage is a routine piece of business for legislators, but in some years, it becomes more of a political issue. Congress struggled with this matter in 2021, and after protracted negotiations, finally extended the debt ceiling limit to a level that allowed continued issuance of Treasury debt securities into early 2023.

 

What happens if Congress doesn’t raise the debt ceiling?

How long can the U.S. Department of the Treasury hold out for Congress to extend the debt ceiling before reaching its debt-issuing limit? The primary method of meeting current obligations, according to Yellen, is to suspend new investments of government pension programs until early June 2023. She says after the debt limit impasse has ended, all of these retirement programs will be fully funded.

Along with delaying selected expenditures, cash receipts taken in by the government also help extend the calendar before Congress acts. “The Treasury Department receives significant tax payments in the first part of the year, which will help the government pay its bills for a time,” says Kevin MacMillan, head of government relations at U.S. Bank. “The major concern about the issue dragging out is that many Republicans have stated they won’t vote for a debt ceiling extension without meaningful spending cuts.” MacMillan says this could make passage of a debt ceiling extension more contentious.

Without a debt ceiling extension, the U.S. risks defaulting on its debt. Yellen has indicated that the Treasury department's extraordinary measures may only be effective until sometime in June. She warns of negative consequences if Congress is unable to come to a debt ceiling agreement in a timely manner. According to Yellen, “Failure to meet the government’s obligations would cause irreparable harm to the U.S. economy, the livelihoods of all Americans, and global financial stability.”1

 

Some perspective on the debt ceiling debate

This repeated and ongoing issue creates stress for capital markets, even with Congress’ track record of ultimately voting to raise the debt ceiling. “The issue itself is temporary, and ultimately, government spending catches up,” says Rob Haworth, senior investment strategy director at U.S. Bank. “The bigger question is what it might mean for the economy and financial markets.”

“While the debt ceiling potentially raises issues for the bond market, investors may also become concerned with the level of debt that continues to emerge in the current federal spending environment.”

Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management

The most direct concern is that without the debt ceiling expansion, the government risks defaulting on its Treasury obligations. “Such a move could cause creditors to demand higher interest rates from the U.S. Treasury in order to provide capital,” according to Haworth. If that occurs, it could cause subsequent rate increases for other types of debt, including mortgages, consumer borrowing and business capitalization.

A similar impasse occurred in 2011, when Republicans in Congress squared off against Democratic President Barack Obama over the debt ceiling issue. At that time, investment markets proved to be very volatile as the deadline for legislation approached. Two days before the date when the Treasury Department estimated that it would run out of funds using extraordinary measures, Congress voted to raise the debt ceiling.

Another consequence, however, was a downgrade of U.S. Treasury securities below the highest, triple-A level for the first time in history, by a major credit rating agency. That did appear to cause higher interest rates on U.S. Treasuries as a result.

“While the debt ceiling issue potentially raises issues for the bond market, investors may also become concerned with the level of debt that continues to emerge in the current federal spending environment,” says Haworth. He suggests that at some point in the future, the amount of debt that’s been issued will impact the supply-demand balance for bonds, possibly affecting interest rates.

 

Economic and market considerations

If the debt ceiling issue again reaches a critical point and becomes difficult to resolve on a timely basis, it could cause a hit to the economy, though the damage may be short-lived. “Typically, one of the first spigots to be shut off is salaries to federal workers,” says Haworth.

Ultimately, the pain may spread to those who receive direct payments from the government, such as Social Security recipients. “There are short-term impacts from that,” says Haworth, “but once funding is restored, everyone is usually made whole.” He points out that while this can create financial difficulty for many, the overall impact to the economy, historically, has been modest.

Adds Eric Freedman, chief investment officer at U.S. Bank, “This looks to be more of a short-term issue. There’s nothing specifically we as investors can do to prepare for what’s ahead as this issue plays out.” Freedman points out that no significant long-term consequences resulted from the credit rating downgrade in 2011, despite its unprecedented nature.

 

Managing the government’s budget

Before the close of business in December 2022, Congress did push through an agreement to budget for the government’s expenditures through the end of the fiscal year, September 30, 2023. It was part of an omnibus legislative package that included new, important retirement provisions. However, this issue is separate from raising the debt ceiling and authorizing the issuance of additional government debt – a matter left unresolved when Congress adjourned in December 2022.

The potential for an impasse over the debt ceiling in 2023 seems increasingly likely given recent news accounts of the positions of various members of Congress. While a number of Republicans, now in the majority in the House, are trying to implement spending cuts as part of a debt ceiling deal, President Biden and Democratic party leaders in the U.S. Senate have vowed to fight major spending cuts.2

The legislative agenda captures significant headlines from time-to-time but represents just one factor to consider as you assess how your own portfolio is situated given the current environment and your long-term financial goals.

Talk to your financial professional if you have questions or want to discuss any portfolio options you wish to consider.

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  1. Tankersly, Jim, “Speaker Drama Raises New Fears on Debt Limit,” The New York Times, Jan. 7, 2023.

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