Economic News
Debt Ceiling Fallout Makes Investors Nervous
Investors are getting skittish
Investors are getting concerned about what could be a protracted fight about the lifting of the U.S. debt ceiling later this year due to the bumpy start for the new U.S. Congress.
Republicans believe that when the U.S. Treasury reaches its legal borrowing limit of $31.4 trillion in 2023, they will have an opportunity to reduce President Joe Biden’s spending on Democratic initiatives including the environment and new social programs.
The debate over extending the debt ceiling is a common topic in Washington, but some investors are concerned that the Republican party’s slim majority in Congress may give the party’s hardliners the upper hand and make it much more difficult to strike a compromise this time.
Upcoming battle
The drawn-out battle to elect Republican Kevin McCarthy as speaker of the House of Representatives last week may provide a glimpse into the ferocious legislative struggles to come: McCarthy was elected after 15 rounds of voting and after making significant concessions to right-wing extremists. Since 1859, during the volatile years preceding the Civil War, when there were many voting for the speakership, the 14 unsuccessful votes were the most.
According to Maria Vassalou, a co-chief investment officer of Multi-Asset Solutions at Goldman Sachs Asset Management, “the difficulty McCarthy experienced to gain the speakership and the concessions he had to make in the process reflect the challenging path ahead for lifting the debt ceiling.”
Over the past ten years, legislative impasses over the debt ceiling have mostly been resolved before they had a chance to affect the markets. That wasn’t always the case, though; after a protracted stalemate in 2011, Standard & Poor’s decided to reduce the U.S. credit rating for the first time, which rocked the financial world.
According to Eric Winograd, chief U.S. economist at AllianceBernstein, several factors, notably the thin majorities and the diversity of viewpoints in Congress, could make this debt ceiling incident “as disruptive or perhaps even more disruptive than the 2011 one.”
Winograd predicted that this debt ceiling fight will be the most heated in recent memory.
Even though investors’ attention is still mostly on macroeconomic issues like inflation and monetary policy, some of those worries may already be manifesting in the markets.
According to Calvin Norris, portfolio manager and US rates strategist at Aegon Asset Management, the yields on Treasury bills with maturity dates in October through December of this year seem to be a sign that there are some concerns about the debt ceiling.
These yields, which move inversely to prices, were higher on Tuesday than they were on a one-year bill due in September, yielding between 4.67% and 4.75%, indicating that investors are expecting better returns to keep that paper.
According to Norris, “that would imply that some sort of premium is being allocated to bills in that zone where the risk of the debt ceiling starts to grow.”
The Bipartisan Policy Center predicted last year that, in the absence of congressional action, the federal government will likely run out of money no earlier than the third quarter of 2023.
Issues about inflation
Investors are currently less concerned about the debt ceiling because they are more concerned about the economic effects of the Federal Reserve’s aggressive interest rate increases intended to combat inflation.
Additionally, some investors think politicians can come to an agreement on lifting the debt ceiling without seriously upsetting the markets.
In the event that “push comes to shove,” enough votes for raising the debt ceiling may be gathered with a combination of Democrats and some moderate Republicans, according to PIMCO’s head of public policy, Libby Cantrill.
That’s not to suggest there won’t be hiccups along the way, but rather that we are certain the worst-case scenario won’t come to pass, said Cantrill.
Any debt ceiling issues, in the opinion of Edward Al Hussainy, senior interest rate, and currency analyst at Columbia Threadneedle, would be resolved ultimately since it is “a well-rehearsed scenario.”
Others, though, think that extra vigilance could be necessary.
Investment firm Glenmede has taken a more defensive stance, underweighting equities and overweighting cash and fixed income, according to Jason Pride, the firm’s chief investment officer for private wealth, who is concerned that the Fed’s measures may hurt the economy and business profitability.
Pride noted that the growing anxiety over the debt ceiling is “an extra little explanation on top” for the company’s approach.
Pride remarked, “You have a House where the leadership has not solidified. “That has to increase the scenario’s risk.”
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