Debt Ceiling Deja Vu
3min read.
🔄 The Dance Around the Debt Ceiling (are you dizzy yet?)
Can't help but feel like you're stuck in a loop of a Groundhog Day sequel with all the noise surrounding the debt ceiling? You're not alone. The debt ceiling, as you might know, mirrors the maximum amount the US Congress allows the government to borrow. Congress holds the power to bump this limit up a notch when the government dances dangerously close to it or, even worse, maxes out. The US Treasury Department shares that since 1960, Congress has stepped in a staggering 78 times to hike the debt ceiling, sometimes under considerable political strain.
Come January this year, the US made another dent in this debt ceiling, setting off the alarm bells at the Treasury Department. They've been playing the balancing act, employing "extraordinary measures" to keep existing debts and obligations in check. But Treasury Secretary Janet Yellen has sounded the alarm louder - hinting that the countdown clock to the "X-date" - the dreaded day when these extraordinary measures dry up - is ticking fast towards a deadline (as soon as June 1st). With the countdown on and no political consensus to up the debt ceiling, I’ve started to field phone calls concerning how a breach could impact my client’s portfolios.
📚 Investor Implications
As these debates around the debt ceiling leave us all biting our nails, the real-world implications remain to be seen. Though Congress has a history of continually ramping up the debt limit, should they drop the ball this time, it's anyone's guess how things will pan out. The fallout could range from delayed salaries for federal workers to defaults on federal debt interest and principal payments. But from an investment standpoint, fortune-telling these scenarios isn't productive, as the market has already factored in the potential range of outcomes. Staying on track with a sound investment plan geared towards long-term goals can help you weather the current storm.
🎚️ One of Many Levers
As we inch closer to the X-date with no political resolution in sight, we could see ripples of reactions and heightened volatility shaking both equity and fixed-income markets. That said, the debt limit tug-of-war is but one of the many levers that pull at security prices.
Case in point - during the 2011 debt ceiling crisis, we saw US Treasury yields dip during the tense negotiations that culminated in August, even as S&P downgraded the credit rating of US sovereign debt from AAA to AA+.
EXHIBIT 1 - Falling Yield - Daily 5-Year US Treasury Yield, 2011
Source: Dimensional Fund Advisors - US Department of Treasury - Past performance is no guarantee of future results.
A glance back at past instances doesn't give us a crystal ball into the future, but it offers a critical reminder - trying to outsmart the market is a futile exercise. Embracing an investment approach that folds in current price and yield information lets us, as investors, tap into the market's shared knowledge and real-time responsiveness to shifting market conditions.
🤷 Embracing Uncertainty
The nature of investing comes with its fair share of market volatility. Earning risk premiums demands that we stare uncertainty in the eye, and these times of heightened uncertainty often rouse volatility. Preparing for this uncertainty with an adaptable, nimble investment process can help you steer through turbulent market waters while keeping your eye on the prize. Jumping at short-term uncertainties could jeopardize your progress toward long-term goals.
A flexible investment approach allows us to roll with the punches as market prices or credit spreads fluctuate. It also promotes sensible portfolio management, potentially dodging unnecessary trades during periods of heightened volatility.
🧰 What’s in the Toolbox?
In times of uncertainty, diversification remains a crucial tool in our risk management toolbox. Even if a US government technical default sends shockwaves through global markets, a diversified portfolio of global equity and fixed-income investments, paired with a long-term investment horizon, can be an investor's life raft amidst short-term and local uncertainties.
In the face of uncertainty, remember long-term planning, flexibility, and diversification are your trusty sidekicks.
As always - stay on point!
FOOTNOTES & SOURCES
“Debt Limit,” US Department of the Treasury.
“Debt Limit Letter to Congress Members,” US Department of the Treasury, May 15, 2023.
ADAPTED FROM CLIENT READY MATERIAL FROM DIMENSIONAL FUND ADVISORS, “Mind over Matter: Perspective for Investors on the US Debt Ceiling” Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission
Credit rating agencies like Standard & Poor’s Corporation (S&P) rate the credit quality of debt issues. S&P’s scale is from AAA to D with intermediate ratings of (+) or (-) offered at each level between AA and CCC
