Crunch Time: What Investors Need to Know About the Debt Ceiling Debate

The ability of Congress to agree on a new debt ceiling and spending limit could have significant consequences for markets and investors.

Congress will soon once again be faced with the task of raising the US debt ceiling and negotiating new federal spending limits – and both decisions have the potential to affect markets and investors. The debt ceiling is a limit that Congress imposes on how much debt the federal government can carry at any given time. By law, when the debt ceiling is reached, the US Treasury Department can no longer issue Treasury bills, notes, or bonds.

Past as prologue?
For decades, the debt ceiling was raised without much debate in Congress at all. However, in 2011 we saw a debt ceiling crisis. Republicans had recently taken over the House, and they demanded that President Obama reduce the deficit in exchange for their vote in approving a debt ceiling increase. The result of this negotiation was the Budget Control Act of 2011. This act established caps on the amount of money that could be spent through the annual appropriations process for the next ten years. The Congressional Budget Office estimated it would reduce federal spending by $917 billion. In 2013, Republicans in Congress once again demanded spending cuts as a condition for their vote in raising the debt ceiling. This time, the disagreement resulted in a temporary government shutdown.

Rowdy neighborhood
In today’s Congress, bipartisan support is tough – not impossible, but tough. Democrats in the House want to reintroduce what’s known as the Gephardt Rule. Named after former Representative Dick Gephardt of Missouri, it would allow for the debt ceiling to be raised automatically every time Congress passes a budget. In the Senate, the debt ceiling has historically been less of a controversial issue. However, there are no guarantees that the Republican-controlled Senate or the Republican-controlled White House will agree to any resolution proposed by House Democrats. Critics of the Gephardt Rule argue that without a stand-alone vote on the debt ceiling, Congress will fail to control government spending.

The border security debate
The situation may also be complicated by President Trump’s declaration of a national emergency over border security. Critics see the declaration as an attempt by President Trump to circumvent Congress and use his executive power in an unprecedented way. Supporters of the declaration – including many GOP lawmakers – view it as a move that is necessary to maintain law and order at the US-Mexico border. While the emergency declaration is not tied directly to the debate on raising the debt ceiling, it does color the debate between Republicans and Democrats as they are forced to come to an agreement. Partisan bickering could make the debt ceiling negotiations more complicated than they need to be.

Marching ahead
The federal government was scheduled to hit the debt ceiling limit on March 1. In response, the Treasury Department deployed accounting maneuvers known as “extraordinary measures” that will allow the government to remain functioning at full capacity until sometime in September or October. Treasury Secretary Steven Mnuchin has said that Congress should agree to increase the debt ceiling limit once new spending is approved. In the shadow of the longest government shutdown in US history, which ended after 35 days on January 25, lawmakers from both parties are likely uninterested in returning to a shutdown scenario.

The debt ceiling debate centers on paying for spending initiatives that have already been agreed upon. Conflicts over these commitments can jeopardize the creditworthiness of the United States government, and this trust plays a crucial role in global markets. In both 2011 and 2013 the credit rating of the US government was downgraded as a result of excessive partisanship over the debt ceiling. Markets were particularly volatile in 2011.

There seems to be consensus in Washington that Congress should come together and agree upon a new debt ceiling and spending limit. However, if they are unable to reach an agreement in a reasonable way, investors should be mindful that similar consequences to those we experienced in 2011 and 2013 could occur once again.

The views and opinions expressed may change based on market and other conditions. Unless otherwise noted, the opinions of the speakers provided are not necessarily those of Natixis Investment Managers or any of its affiliates.

This material is provided for informational purposes only and should not be construed as investment advice.

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