What You Should Know About the Debt Ceiling Debate

If you’ve been keeping up on news coming out of Washington, D.C., you know that Congress is once again grappling with a need to raise the federal government’s debt ceiling limit. Legislation to that effect would provide the U.S. Treasury with authorization to issue new debt to help cover the costs of programs already approved by Congress. This is a typically routine action that avoids the U.S. defaulting on its loans. However, given the polarized political climate and hardened positions on both sides of the aisle, Congress so far has not negotiated an agreement to raise the debt ceiling by the summer deadline.

How could the issue play out and what are the possible ramifications for the financial markets?

What’s happening in Washington
The need for Congress to take action and increase the debt ceiling occurs periodically. This year, similar to prior instances, it has become a political matter with differing views on how to effectively solve the problem at hand.

If the debt ceiling is not raised on a timely basis, the federal government could default on its debt. This is significant as investors look upon U.S. Treasury bonds as debt securities that are backed by “the full faith and credit of the United States.” A default could tarnish that reputation, and potentially result in the government having to pay higher interest rates to attract bond investors.

At this point, the U.S. Treasury has reached its debt ceiling limit as previously authorized by Congress, and is undertaking “extraordinary measures” to avoid a debt default. Treasury officials indicate that these measures will likely be exhausted by June 2023. At that time, without Congress acting to raise the debt ceiling, a U.S. government default becomes a real possibility.

Markets maintain a wary eye
What would a debt default mean? In a speech on Feb. 14, 2023, Treasury Secretary Janet Yellen stated that in the longer term, a default would mean “Future investments, including public investments, would become substantially more costly.” If interest rates on government bonds were forced higher, the impact could be felt across the bond market, pushing interest rates on other types of debt higher.

More directly, according to Yellen, “the federal government would be unable to issue payments to millions of Americans, including our military families and seniors who rely on Social Security.” Costlier borrowing could also reverberate to consumers as they obtain mortgages, car loans and other forms of debt.

Would this have a significant and extended negative effect on the economy? That’s an open question, but minimally we should expect that the longer the debate lingers and the closer the deadline draws near without resolution, we may face increased market volatility. While you don’t want to overhaul your long-term financial plan based on speculation over how it will play out you may want to consult with your advisor about how to address potential, near-term ramifications that could be reflected in more volatile markets.