After an extended standoff, the U.S. debt ceiling was raised on Saturday June 4, just before the revised June 5 “X-date,” or the day the U.S. government would not have been able to pay all its obligations. We averted the debt default, but this process exposed more glaringly the deep divisions we have in our country.
The Fiscal Responsibility Act of 2023, as the bill is called, suspends the public debt limit through January 1, 2025, after the 2024 presidential elections. If the U.S. were to default, it could have led to many negative outcomes, including unpaid bills, a potential credit downgrade, and severe consequences in both the U.S. and global financial markets. Already in May of this year, rating agencies Fitch and DBRS Morningstar had put the United States on credit watch for a possible downgrade.
However, the bill in many ways just kicks the can down the road, and in the process raises a lot of dust. With the debt-ceiling suspension set to end in early 2025, it could become a point of contention in the 2024 presidential election. On the financial side, the government needs cash to pay its obligations and replenish its buffer. This would result in a surge in Treasury-bill sales in the months to come. This deluge of Treasury securities can impact other areas of fixed income adversely as the money moves from other fixed income securities to Treasurys. Purchases of new Treasurys will also move money away from the bank reserves and will put pressure on banks and other financial institutions.
With the removal of uncertainty on debt ceiling, economic fundamentals resume their pace. If employment and inflation do not show a significant softening, the Fed could raise its policy rate by another twenty-five basis points.
The biggest fallout of this debt ceiling fiasco is the reputation of the U.S. globally. This will be another catalyst for foreign governments to re-evaluate what percentage of their reserves they park in U.S. dollar-denominated debt. Treasurys are regarded as the risk-free asset against which financial assets around the world are benchmarked, especially for U.S.-based investors. Decreasing trust in Treasurys will demand a higher risk premium over time, and this would impact the pricing of other financial assets. This could contribute to a weakening of the U.S. dollar.
The debt default has been averted, but only by kicking the can down the road. And the kicking happened on a dusty rocky road, and in the process raised much dust, and injured our toes.
Lavina Nagar, CFP(R) is the president and founder of Maya Advisors, Inc., a financial planning and investment firm in Palo Alto, California.