This is your captain speaking…
When you’re on a commercial flight, and the plane is approaching turbulence, the captain comes on the intercom to let you know to buckle up and expect ‘rough air.’ There should be similar warnings about ‘rough air’ in the markets, and this is a good time to offer one.
The market turbulence that we see approaching is a consequence of the debt ceiling debate—or, rather, the refusal of Congressional leaders to agree to raise the limit on the amount of bonds the government is allowed to sell to finance its operations. The legal limit on the amount of Treasury debt that the government can issue is periodically raised—and it is always because Congress has already authorized a budget that will exceed the debt limit.
Yes, you read that right. Congress created a gap between revenues collected and expenditures, and now is threatening not to authorize the payments that were approved. Don’t try this at home.
Of course, this is a political issue, as are all things in Washington. The Republicans, who control the House of Representatives, are insisting on tying spending cuts to the agreement to raise the debt ceiling. The White House, however, is requesting a “clean” bill to raise the ceiling and proposing tax increases to reduce the deficit over time.
How likely is a default? The U.S. government reached the debt limit ($31.38 trillion) on January 19th and has since been relying on accounting tricks like deferring pension investments to keep the doors open and the bond payment checks from bouncing. We are now on a near-approach to what insiders call the ‘x-date,’ the unspecified time when those measures will be insufficient, and the government will have to start deciding who to pay and (more to the point) who not to pay out of its diminishing resources. It’s worth pointing out that previous debt-ceiling brinkmanship caused credit agencies to lower America’s credit rating—once the highest in the world.
You can bet that quick-twitch traders, whose activities drive short-term market movements, are carefully watching this dance on the edge of default. If the government does run out of its ability to pay bond-holders and workers, those traders would most likely retreat to the sidelines, and there would be at least short-term panic among lay investors who would see sharp lurches in the value of their stock holdings. None of this would affect the actual value of shares of stock (or the value of public companies) in any way, but in the short-term, especially when there are screaming headlines of potential default and dire economic consequences, confidence (or lack thereof) trumps rationality every time.
We have been here before. Indeed, congress has increased the debt ceiling 78 times since 1960! Ultimately, both sides will come to an agreement, avoid default, and some semblance of normalcy will be restored. In the meantime, the captain is advising you to fasten your seat belt.
Canopy Commentary - Debt Ceiling Debate
April 28, 2023