The US Treasury Secretary, Janet Yellen, recently warned Congress the country was rapidly approaching the limit on the amount of national debt that can be incurred by the US Treasury, known as its debt ceiling. She has urgently called for a resolution, warning failure to do so could risk a US default on its financial obligations. The US's debt ceiling is currently set at US$31.4trn.
This is not the first time the US has neared its debt ceiling. To help avoid defaults, it can be raised and has been over 90 times in the past 63 years, but this is a highly divisive issue in US politics. The confidence in it being raised this time is lower than on previous occasions.
The US economy in 2023
In the US, there have been some positive developments of late, with inflation down to 6.5% in the 12 months to December (from 7.1% in November) and a resilient labour market meaning unemployment fell to 3.5% in December, equalling decade lows.
Despite that good news, the US – like many major economies around the world – still faces significant headwinds. According to the World Bank this ongoing “period of pronounced weakness” was behind a raft of its recent growth revisions, with the 2023 projection for the US being cut from 2.4% to just 0.5%. Therefore, the possibility of any default could have serious repercussions for the US and other global economies closely linked to it.
There are also other issues of which investors should be mindful. The US equity market has become more concentrated in the past decade, dominated by tech giants such as Amazon and Apple. While this has been a benefit for the US, pulling the country's market up in recent years, the tide has turned, and this market is now seeing different leaders emerge.
The political hurdles
The immediate challenge now is a political one. For the debt ceiling to be raised, Congress support is needed from both Democrats and Republicans. Given the latter are politically opposed to further borrowing, we can expect debates and political bargaining with Republicans likely to have their own demands.
The political negotiations will likely begin in April once the government has a better idea of the country's tax situation and, though it is impossible to predict how this will be resolved, it is worth remembering the US debt ceiling has been raised before. As such, political noise could just be par for the course, but it would be unwise to blindly assume this is the case. Markets do not like political instability, so until a compromise is reached, there may be some volatility in US markets during this period.
What could this mean for investors?
- The debt ceiling is the upper limit the US Government can borrow.
- In theory, if the debt ceiling is not extended it could mean the US defaults on its debt.
- A default on US government debt would send shockwaves through global markets.
- The Republicans are opposed to increasing the debt ceiling and the Democrats are in favour.
- Based on history, a last-minute resolution is likely to be found.
- Until a compromise is reached there may be some US market volatility.