Our Perspective on the Debt-Ceiling

May 25, 2023

Once again, U.S. citizens and global investors find themselves sitting in the cheap seats, watching the political drama unfold in D.C., and trying to find some semblance of meaning amid the finger-pointing, grandstanding, and posturing of our elected officials as it relates to the debt ceiling. As of June 1st, under current policy, the U.S. government would not be able to meet its financial obligations to its employees, citizens, and creditors. If that were to occur, there would be short-term implications to the stock and bond markets, and potentially long-term implications to the borrowing costs on U.S. debt. The world may tire of repeated political brinkmanship, with debt ceiling debates and the status of the U.S. dollar as the global reserve currency potentially at risk. But let’s cut right to the chase:  the overwhelming consensus is a deal will be reached in the final hour before the June 1st deadline. 

It is safe to say that no one wants the U.S. government to default on its debt. Paraphrasing comments from Libby Cantrill with PIMCO, Republicans nor Democrats have any political incentive to default, but neither side seems to have any political incentive to make concessions, either, before they absolutely must. Immigration reform (for Republicans), tax increases (for Democrats), work requirements for specific entitlements (i.e., welfare programs) and changes to Medicare reimbursements are all part of the debate. With respect to the markets, a cap on ‘discretionary’ spending (~25% of the $6 trillion budget) is a focal point due to the impact on the U.S. economy. It is a painful process to watch this debate from the cheap seats. Libby’s analogy is worth sharing, “Passing the debt ceiling is like passing a kidney stone – we know it will pass, it is just a question of how painful it will be. We would assert we are in the painful period right now.” 

Although investors must consider all of the potential outcomes mentioned above, it’s pure conjecture at this point. The debt ceiling has been raised over 100 times since it was initially passed by Congress during World War I. Over the last 20 years, the U.S. debt limit has been raised 20 times. Earlier today (Thursday, May 25th), Dimensional’s research team reminded us that 5-Year U.S. Treasury yields actually declined (Treasury bond prices increased) prior to and after the 2011 debt limit crisis. Investor decisions, which drive market returns, are formed by many factors. Yes, political uncertainty is one of them, but it is one of many. 

Like kidney stones, this too shall pass. The volatility of recent weeks, and coming days, will subside. Then, we can get back to our long-term perspective in which the market has rewarded disciplined investors with reasonable risk-adjusted returns over time.