Nanette Abuhoff Jacobson, Managing Director and Multi-Asset Strategist at Wellington Management and Global Investment Strategist for Hartford Funds
Michael Medeiros, CFA US Macro Strategist at Wellington Management
April 17, 2023
The U.S. has maxed out its borrowing again, with the $31.4 trillion debt ceiling appearing on investors’ radar as a potential tail risk for markets.
The U.S. debt ceiling is a critically important issue, not only in Washington, but also for the global economy and markets. Failure to raise it in a timely manner could result in significant negative fallout, from default to downgrade and more.
Hartford Funds and Wellington Management experts provide further perspective on the potential market impact of these political developments, as well as possible investor implications.
What should investors watch closely as negotiations proceed?
As the outcome for these negotiations continue to hang in the balance, here are a few areas investors will want to track:
- June 5, 2023 is the earliest possible date (the “X date”) that the government could default on its debt obligations, according to the U.S. Treasury but that could change depending on the revenue picture.
- While default is not our base case outcome, there are enough red flags to warrant investors’ attention, given the potentially serious risks of Congressional inaction.
- The current U.S. political environment, coupled with a narrow majority in the House of Representatives, poses a worrisome backdrop ahead of the upcoming debt-ceiling negotiations.
What are the odds of the U.S. breaching its debt limit?
The market has assigned low odds to a U.S. government default, which makes sense given the numerous debt-ceiling increases since 2011. Both political parties recognize the consequences of inaction could be catastrophic for the U.S. economy — and the global economy and financial markets. If Congressional negotiations fail and push the U.S. government to the edge of default, the debt ceiling can be raised through presidential executive order.
However, the stakes are much higher compared to years past: U.S. public debt is now 127% of GDP. As the chart shows, that’s more than double what it was in the late 1990s.
Investor implications of the current debt ceiling negotiations
The prospect of a Congressional impasse could stoke market volatility in the short term, but the debt ceiling will eventually be lifted (aided by mounting public pressure to do so).
Consider these potential investment implications:
- Higher credit-risk premium on U.S. government bonds: Waning investor confidence in a timely resolution of the debt-ceiling quagmire may be reflected in a steeper U.S. yield curve. Whether interest rates would rise (due to a larger credit-risk premium) or fall (given higher recession risk) is less clear.
- A weaker U.S. dollar, a potential boon for non-U.S. risk assets: A perception that the U.S. government is unwilling or unable to pay its debts would be a weaker currency story for the U.S. dollar and could support non-U.S. risk assets. That said, the U.S. dollar remains the world’s dominant reserve currency, with global central banks holding around 60% of their reserves in greenbacks.
- Defensive sectors could potentially outperform: Increased recession risk may benefit more defensive equity sectors, such as healthcare, utilities, and consumer staples.
- Upside for gold: A weaker U.S. dollar amid a debt-ceiling battle in Congress could be supportive of gold prices, at least temporarily.
Prepare for unexpected market events
While we believe that the political parties will eventually come together to find a solution on the debt ceiling, the present standoff has the potential to fuel market volatility in the interim. Reach out to your financial advisor — they can help you position your portfolio for potential market volatility.