The Debt Ceiling Standoff
Congress is currently debating whether to extend the federal borrowing limit, or debt ceiling before the critical deadline in mid-October, when the United States would be in danger of default on its debt. The House passed a bill to keep the government debt ceiling lifted through 2022, but the bill faces uphill battles in upper chamber of Congress.
Figure 1: National Debt and the statutory limit, 2001-2021. Graph from White House Office of Management and Budget (limit); Treasury Department (debt, suspensions)
Typically, investors demand higher yields for Treasuries with longer maturities to compensate for the risk that inflation could accelerate or that the Federal Reserve could raise interest rates. This applies even to the shortest-term debt – securities known as bills that carry maturities of one year or less. In recent weeks, however, bills maturing in mid-October through mid-November have offered higher yields than those maturing in subsequent months. That is due to the risk that the government might reach its borrowing limit around that time period and not immediately have the money to pay its creditors.
Figure 2: Treasury bill yield by maturity, July 2021 – September 2021. Graph from Tradeweb
Fed Chairman, Jerome Powell, noted on the impeding crisis, “It’s just very important that the debt ceiling be raised in a timely fashion so that the United States can pay its bills when and as they come due.” Powell warns that the central bank doesn’t possess the ability to shield financial markets or the U.S. economy from severe damage should Congress fail to lift the nation’s debt limit in coming weeks and precipitates a default on government obligations (2).
U.S. Treasury Secretary Janet Yellen told lawmakers on Tuesday the government could run out of cash by October 18 unless Congress acts to lift the federal debt limit in advance of the Treasury Department exhausting efforts to preserve resources. “At that point, we expect Treasury would be left with very limited resources that would be depleted quickly…It is uncertain whether we could continue to meet all the nation’s commitments after that date” (3).
A government default could mean many programs would risk not being funded, such as Social Security and veterans benefits, as well as salaries to federal employees and military members.
Goldman Sachs estimated the Treasury may need to halt more than 40% of payments, including some to U.S. households, if the ceiling is not raised or suspended (4). Therefore, a default would cause major disruptions across the entire economy, from individuals to businesses, as most loan rates are linked to government securities.
The debt ceiling came to be from the necessity of war funding in the mid-20th century. As the government needed more cash to fund war efforts, Congress needed to approve each instance of borrowing. Since then, the limit has been raised 98 times, without a single instance of default.
Nonetheless, as markets remain volatile and interest rates climb, investors should position themselves within a diverse portfolio of securities that allow them to maintain steady sight of long-term goals. Although government default looms over short-term investor sentiment at the moment, long-term economic prospects remain high.
1) The WSJ, September 28, 2021
2) Bloomberg, September 22, 2021
3) Reuters, September 28, 2021
4) The WSJ, September 24, 2021