The debt ceiling debate is once again flooding the national airwaves, as the U.S. rapidly approaches what is known as the “X Date” – or the date when the U.S. Treasury would run out of cash needed to pay bills.

The Treasury owes interest payments on existing debt, but the department also needs cash to pay Social Security, veteran’s benefits, and paychecks for federal employees and military families. It is important for readers to understand that raising the debt limit does not authorize new spending by Congress – it simply allows the Treasury to issue new debt to cover spending already authorized by Congress.1

As such, raising the debt ceiling is critical and necessary for the country to pay its bills on time, but it is also routine – the debt limit has been raised almost 100 times since World War II. Before the world wars, Congress had to approve borrowing every time debt was needed to finance new spending, but war spending changed the process – and in some cases, made it political.

Some readers may recall the “fiscal cliff” scare back in 2011, which was so down-to-the-wire that Standard & Poors lowered the U.S.’s credit rating from AAA to AA. According to the Government Accountability Office, the lowered credit rating cost U.S. taxpayers about $1.3 billion for the fiscal year, which is small relative to total spending but still represents an avoidable cost. The stock market endured a real correction in 2011, falling some -19% from the intra-year peak but ultimately finishing flat for the calendar year and rising +13% in 2012.

Then in 2013 many readers likely remember the U.S. government shutdown that lasted 16 days (from October 1 to October 17). In that year, the government failed to appropriate funds for the fiscal year 2014 nor were they able to pass a continuing resolution to supply financing for government obligations.

Eventually – and as they always have – Congress passed a bill funding the government and raising the debt ceiling, but the process for getting there was politically fraught. Despite the very public debate and political infighting, the stock market (S&P 500 index) did not react much at all. As you can see in the chart below, the S&P 500 pulled back slightly but did not waver from its overall upward trend for the year. The index finished up +30%.2

Source: Federal Reserve Bank of St. Louis3

The debt ceiling issue is nothing new, and Congress has gone down to the wire with the issue before. Despite political tension, 11th-hour deals have always found a way to get done. While it appears that the politics has gotten uglier and more hostile over the years, I do not foresee a scenario where the U.S. government would be allowed to default on its debt – such an outcome benefits no one and would only serve to disrupt financial markets and raise borrowing costs.

The impact on the equity markets in 2021 may just depend on how far Congress lets the issue go, with the worst-case scenario being the Treasury running out of cash and missing payments on existing obligations (“X Date”). The Treasury estimates the X Date could fall somewhere between October 15 and November 4, so at the very latest Congress needs to act by then.

Bottom Line for Investors

For investors, the uncertainty surrounding the debate could lead to some short-term volatility, but I do not believe the medium to longer-term trajectory of the markets or the economy should be seriously affected. We’re still on a strong path of growth, in my view, and corporate earnings should not be materially affected by a political process.

Disclosure

1 Wall Street Journal. September 24, 2021. https://www.wsj.com/articles/us-debt-ceiling-explained-11632429692?mod=djemRTE_h

2 Wall Street Journal. September 27, 2021. https://www.wsj.com/articles/senate-republicans-set-to-block-bill-tying-short-term-funding-bill-to-debt-ceiling-11632772705?mod=hp_lead_pos1

3 Fred Economic Data. September 27, 2021. https://fred.stlouisfed.org/series/SP500#0

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