Debt ceiling risk threatens markets in 2023

Debt ceiling risk threatens markets in 2023

When the US nearly failed to raise the debt ceiling in 2011, stock markets fell more than 10% and US government debt was downgraded by S&P from AAA to AA+. Now there are fears of a debt ceiling risk for markets again in 2023. The political environment is similar to 2011, although politicians may have learned their lesson.

Debt ceiling looms in 2023

Currently, the debt ceiling is just under $31.4 trillion. The American public debt, which is not exactly comparable since certain debts are excluded from the calculation of the debt ceiling, amounts to 31,300 billion dollars. Most estimates call for the debt ceiling to be reached in early 2023. We are clearly getting closer.

The Secretary of the Treasury may be able to use extraordinary measures to purchase several months of additional time beyond that. Still, the debt ceiling will likely approach sometime in 2023.

The lame duck’s plans fail

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

Democrats could use reconciliation to raise the debt ceiling, but they may not have enough time for that process. Negotiations continue to find a possible deal, but this is a key leverage point for Republicans, who will control the House from January 2023. In the Senate, Democrat control remains very thin, and Senator Joe Manchin has indicated that he might not support an increase in 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 US government bond market is a huge part of the financial system, and many other financial instruments are priced against US Treasury bonds as so-called “risk-free” assets. Reaching the debt ceiling first hampers, then ultimately blocks, the US government’s ability to pay interest and raise new debt.

If the government does not pay the interest on the national debt, this has wide repercussions on the financial markets. Not paying interest is more common for struggling companies facing bankruptcy than for the US government.

What happened in 2011

The US government came days after it defaulted on its debt in August 2011, causing its debt to deteriorate. It also caused a sell-off in the stock market. The selloff built in the final weeks of July 2011, then continued in the days after the cap was raised due to S&P’s downgrade of the US government’s credit rating.

Many countries, including Canada, Germany and Australia, now have higher S&P debt ratings than the US, as do two US companies – Microsoft
and Johnson and Johnson. This outcome partly reflects the 2011 debt ceiling negotiations.

Of course, it’s no coincidence that the debt ceiling issues of 2011 arose after Republicans seized control of the House and Senate midterm in 2010 under a Democratic presidency, leading to a stalemate. Politics. Although the Democrats retained the Senate this time around, the Republicans took the House. This could lead to a similar political stalemate in 2023. Importantly, the debt ceiling negotiations will likely be a key lever for Republicans.

Arguably since the events of 2011, the risk of debt ceiling negotiations is now a little more “integrated” into financial markets, and perhaps better understood by politicians. It seems likely that a compromise can be found to raise the debt ceiling.

Additionally, it should be noted that many debt ceiling debates have taken place since 2011 with similar levels of concern, but less ultimate market impact. However, debt ceiling risk could weigh on markets in 2023, and a positive outcome cannot be guaranteed.

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