Debt Ceiling Risk Looms For Markets In 2023

When the U.S. came close to not raising the debt ceiling in 2011, stock markets fell over 10% and the debt of the U.S. government was downgraded by S&P from AAA to AA+. Now, there are fears of debt ceiling risk for markets once again in 2023. The political environment is similar to 2011, though perhaps politicians have learned their lesson.

The Debt Ceiling Is Looming In 2023

Currently the debt ceiling is a little under $31.4 trillion dollars. U.S. government debt, which is not precisely comparable, since some debt is excluded from the debt ceiling calculation, stands at $31.3 trillion. Most estimates have the debt ceiling being reached in early 2023. We’re clearly getting close.

The Treasury Secretary may be able to use extraordinary measures to buy several months of additional time beyond that. Still, the debt ceiling is likely approaching at some point in 2023.

Lame Duck Plans Failing

Democrats had suggested that the debt ceiling would be raised during the lame duck session after the midterms. That’s now looking less likely.

Democrats could use reconciliation to raise the debt ceiling, but they may not have sufficient time for that process. Negotiations continue to find a possible deal, but this is a key point of leverage for the Republicans, who will control the House from January 2023. In the Senate, the Democrats control remains very slim, and Senator Joe Manchin has indicated he may not support an increase to the debt ceiling without potential budget cuts and bipartisan support. These negotiations would all take time.

Market Reaction

If you hold debt, you expect to be paid back and receive interest payments. The market for U.S. government borrowing is an enormous part of the financial system, and many other financial instruments are priced off U.S. Treasuries as the so-called ‘risk-free’ asset. Hitting the debt ceiling first hinders, and then ultimately blocks, the U.S. government’s ability to pay interest and raise new debt.

If the government fails to pay interest on the national debt, that has broad repercussions for financial markets. Failing to pay interest is something more common to struggling companies facing bankruptcy than the U.S. government.

What Happened In 2011

The U.S. government came within days of debt default in August 2011, causing its debt to be downgraded. This prompted a sell-off in the stock market too. The selloff built in the final weeks of July 2011, and then continuing in the days after the ceiling was raised due to S&P’s rating downgrade of the U.S. government’s credit rating.

Many countries including Canada, Germany and Australia now hold a higher S&P debt rating than the U.S., as do two U.S. companies – MicrosoftMSFT
and Johnson and Johnson. This outcome is, in part, a reflection of the debt ceiling negotiations of 2011.

Of course, it’s no coincidence that the 2011 debt ceiling issues came after the Republicans won control of the House and Senate in the 2010 midterms under a Democratic Presidency, leading to political gridlock. Though the Democrats have kept the Senate this time around, Republicans have taken the House. That could lead to similar political gridlock in 2023. Importantly, debt ceiling negotiations are likely to be a key point of leverage for Republicans.

Arguably since the events of 2011, the risk of debt ceiling negotiations is now a little more ‘priced in’ to financial markets, and perhaps better understood by politicians. It seems likely a compromise can be found to raise the debt ceiling.

Also, we should note that many debt ceiling debates have passed since 2011 with similar levels of concern, but less ultimate market impact. However, the debt ceiling risk may weigh on markets in 2023, and a positive outcome can’t be guaranteed.

Source: https://www.forbes.com/sites/simonmoore/2022/11/17/debt-ceiling-crash-risk-increases-for-financial-markets-into-2023/