US Debt Ceiling: What it is and what it means for you

Once again, Congress and the White House are wrangling over an increase in the debt ceiling. The stakes are high. Failure to do so would lead to a default on the federal debt, which could have far-ranging economic consequences.

If history repeats, a deal will ultimately be reached. In the meantime, political uncertainty could disrupt financial markets—and also create investment opportunities. Says Lars Schuster, institutional portfolio manager in Fidelity’s Strategic Advisers group: “It’s unnerving to see these headlines. The good news is that historically volatility in the markets tends to be fairly short-lived. This could result in a good buying or portfolio rebalancing opportunity for long-term focused investors.”

What is the debt ceiling?

The federal debt ceiling is a limit set by Congress on the amount of money that the US Treasury can borrow to fund the government’s operations and make interest payments to the people and institutions who own US government-issued bonds. Since the ceiling was reached in January, the Treasury has relied on so-called extraordinary measures to keep operating until Congress reaches an agreement for a debt limit increase. If the debt ceiling is not raised, the Treasury would be unable to issue more Treasury securities and the nation could default on its debt, potentially by June.

Since 1985, the Treasury has had to resort to extraordinary measures 11 times and each time Congress has acted to forestall default, though often at the last minute after considerable high-stakes wrangling. Alice Joe, vice president for Federal Government Relations, says neither party in Congress views default as an option, but the highly partisan environment is making it harder to reach an agreement to extend the debt limit than has been the case in the past.

The possibility that the Treasury could run out of money may cause some short-term volatility in financial markets and the flurry of fear-inducing news stories that often accompany choppy markets. As the chart below shows, markets have historically risen on average in the months following an agreement to raise the debt ceiling.

The debt ceiling has, in the past, spurred contentious and prolonged debate about fiscal responsibility and the growing national debt.

In 2011, the disagreements went so far that the credit rating agency Standard & Poor’s downgraded the US credit rating to AA+, one step below the best rating of AAA. Standard & Poor’s cited the growing deficit and the prolonged debate as reasons for the downgrade.

Historically, raising the debt ceiling has not been a battle legislators want to fight. Administration officials usually work behind the scenes to convince legislators of the importance of raising the limit relatively quickly and without fanfare. This approach helps limit financial market uncertainty, minimizing the potential for government borrowing costs to increase amid a debt-ceiling debate, while reducing investor concerns.

US Debt Ceiling: What it is and what it means for you
Source: Daily data from Bloomberg Finance, L.P., 3/31/2023. U.S. Department of the Treasury.

What is the US national debt?

One thing separating today’s debt debate from those of the past is the larger-than-ever national debt. Publicly held US debt topped 120% of gross domestic product in the third quarter of 2022, according to the US Office of Management and Budget.

And the debt is projected to increase significantly in the future. The Congressional Budget Office (CBO) projects the federal budget deficit will total $13.1 trillion from 2023 through 2032.

What if the US debt ceiling is not raised?

Unless a deal is reached to suspend or raise the debt limit, the US will be in danger of defaulting on our national debt. There are some steps the Treasury is taking to forestall a default, including spending down saved cash and taking other emergency measures. But those extraordinary measures are expected to be exhausted by sometime in early June.

If all of the Treasury’s cash balances are drawn and extraordinary measures have been exhausted, the Treasury would be at the limit of the debt ceiling. Such an outcome has not occurred in the modern era, and it remains uncertain as to exactly what developments would transpire next.

However, if Congress still does not raise the debt ceiling, the US government would have to operate on a cash-flow basis, meaning that outflows (including interest payments on existing Treasury debt) would have to be funded by inflows (i.e., tax receipts and fees). Operating in this manner would require prioritization of payments, which could have several negative implications.

US Debt Ceiling: What it is and what it means for you
Source: Fidelity Investments, July 2021.

For one, this prioritization would place some counterparties in a subordinate position, which could unsettle the markets. For instance, during the debt debate in 2013 when the US was only days away from default, prioritization of payments was discussed as a possible option. While principal and interest payments could potentially continue to flow to bondholders, other payments like Social Security benefits could be suspended.

Also, the rating agencies would most likely place the sovereign rating of the United States under review and would potentially lower the rating if a debt-ceiling increase was not enacted. That could significantly increase the cost of borrowing at the national level.

Furthermore, critical functions to operate the government, including spending for military, Social Security, and other programs, would likely be interrupted, pressuring economic activity. Finally, the timing of tax collections is always uncertain, creating the potential for an inadvertent missed interest payment.

What happens if the US defaults on its debt?

An actual default is unlikely because of the reverberations that could be expected, including:

US Debt Ceiling: What it is and what it means for you
Source: Fidelity Investments, July 2021.

What can investors do about the debt ceiling?

It’s clearly in the best interest of the country to resolve any debt-ceiling issues.

Still, there will always be times of uncertainty. It’s important to take a long-term view of your investments and review them regularly to make sure they line up with your time frame for investing, risk tolerance, and financial situation. Ideally, your investment mix is one that offers the potential to meet your goals while also letting you rest easy at night.

The article is from Fidelity Viewpoints,This article is an original creation by If you wish to repost or share, please include an attribution to the source and provide a link to the original article.Post Link:

Like (1)
Previous May 11, 2023 11:05 am
Next May 11, 2023 12:56 pm

Related Posts

  • A Look into the History of the US Debt-Ceiling Battles

    The United States debt ceiling is a legislative limit on the amount of national debt that the U.S. government is allowed to incur. The debt ceiling is set by Congress and any increase must also be approved by Congress. The U.S. government has reached or exceeded the debt ceiling several times in its history, leading to heated battles between the legislative and executive branches of government. One of the first major battles over the debt ceiling took place in 1917, when the U.S. entered World War I. In order to…

    January 20, 2023
  • Exploring the Complexities of the U.S. Debt Ceiling: Causes, Consequences and Possible Solutions

    The debt ceiling is a legal limit set by the United States government on the amount of debt that it can incur. This limit is set by Congress and is separate from the budget process. The debt ceiling is intended to ensure that the government does not spend more than it can afford to pay back. On January 19, 2023, the United States reached its debt ceiling of $31.4 trillion once again. This is not the first time the country has reached this limit, as the debt ceiling has been…

    January 20, 2023
  • Will the debit limit ceiling crisis to affect my 401(k), Social Security, and Medicare?

    Last week, the Federal Reserve announced its decision to impose a debit limit ceiling on banks. This move is intended to ensure that banks have enough capital to keep them from buckling under the financial strain of a weak economy. However, many Americans are wondering how this move will affect their personal finances, such as their 401(k), Social Security, and Medicare benefits. While changes in banking regulations can have wide-reaching implications, it’s important to understand the specifics of this rule so you can determine what impact it may have on…

    February 3, 2023
  • The Debt Ceiling Battle and Its Economic Impact: Tracing the Origins of the Crisis

    Introduction With the U.S. government facing yet another debt ceiling battle, the economic impact of this recurring crisis is once again in the spotlight. But what exactly is the debt ceiling, and why does it matter? In this blog post, we’ll take a deep dive into the origins of the debt ceiling and explore important questions such as how much interest is paid on our national debt, who owns it, and what would happen if we defaulted on it. So buckle up for a fascinating exploration of one of America’s…

    April 21, 2023
  • Investor Pessimism Grows Without a Debt Ceiling Deal, Boosting Volatility

    Equities are down for the third consecutive day as investors grow increasingly worried about continued brinkmanship in Washington over raising the debt ceiling. With just eight short days until the June 1 deadline recognized by Secretary of the Treasury Janet Yellen as the point at which the U.S. would default on debt, meaningful progress on reaching a deal has been hard to come by for negotiations. While leaders from both parties have at times attempted to strike a positive tone by calling talks productive and effective, an actual agreement that…

    May 24, 2023
  • How worried should we be if the debt ceiling isn’t lifted?

    As the government shutdown continues and politicians remain at a standstill on lifting the debt ceiling, many people are left wondering how worried they should actually be. The truth is, if the debt ceiling isn’t lifted soon, it could have serious consequences for the US economy. In this article, we’ll discuss what would happen if the debt ceiling wasn’t raised and how to prepare your finances in this uncertain time. So if you’re wondering just how worried you should be about the looming deadline, read on to find out more….

    February 24, 2023
  • The Debt Ceiling Crisis and 5 Ways to Prepare for Potential Consequences

    With the US government facing a possible debt ceiling crisis, it’s important that you understand the implications of this looming threat and how to protect yourself from potential financial consequences. In this article, we’ll break down the debt ceiling crisis, explain what it means for you, and provide five ways you can prepare yourself in case of any major economic changes. Read on to learn more! What is the Debt Ceiling Crisis? As the United States federal government continues to rack up debt, there is a limit to how much…

    February 20, 2023
  • The Possible Economic Consequences Across Different Debt Limit Situations

    New analyses by both the Congressional Budget Office and the U.S. Department of the Treasury suggest the United States is rapidly approaching the date at which the government can no longer pay its bills, also known as the “X-date.” History is clear that even getting close to a breach of the U.S. debt ceiling could cause significant disruptions to financial markets that would damage the economic conditions faced by households and businesses. Real time data, shown below, indicate that markets are already pricing in political brinkmanship related to Federal government…

    May 24, 2023
  • 3 Ways the Debt Ceiling Could Impact Your Wallet

    With the recent increase in the debt ceiling, many Americans are left wondering how it might affect their wallet. While the decision to raise the debt limit does not have an immediate effect on your finances, it could have long-term implications that everyone should be aware of. In this blog post, we’ll discuss three ways the debt ceiling could impact your wallet, and what you can do to prepare. We will also go over some of the potential effects on our economy as a whole if action is not taken…

    February 2, 2023
  • Everything You Should Know About the Debt Ceiling

    In this article, we’ll be discussing a topic that is sometimes overlooked but is critically important to understand: the Debt Ceiling. We’ll provide a breakdown of what the debt ceiling is, why it’s important, and how it affects the economy. We’ll also discuss what you can do to ensure your own finances remain secure in light of these issues. With this information in hand, you’ll be better prepared to make decisions that will benefit both yourself and our nation as a whole. What is the debt ceiling? As the United…

    February 24, 2023

Leave a Reply

Your email address will not be published. Required fields are marked *