By Ron C. Dugan, CFA, Vice President and Global Investment Strategist
The problem is that this is more of a political issue than an economic issue. Many believe the proper action to take at this time is to raise the Debt Ceiling so as to avoid even the appearance of a technical default on US government debt. However, the longer we must wait for the US Congress and US Senate to take action on this issue, the greater this problem shifts towards having an economic impact through the potential disruption that this issue could create.
No one should willingly want to increase the Federal Debt Limit at these levels, but the possible downstream ramifications from a technical default could be very disruptive to the capital markets. Consequences would be far ranging from its impact on interest rates, stock prices, investor confidence, to the daily activity of businesses and consumers. Once the Debt Ceiling is reached, the US Treasury cannot borrow additional money to meet its expenditures, such as making interest payments or meeting payments for other government programs.
Nevertheless, certain politicians are taking this opportunity to posture for the next election cycle by demonstrating how they are opposed to increasing the US Government debt levels beyond the current $14.3 trillion debt limit. Several legislators are using this issue as a means to negotiate spending cuts in exchange for their vote to increase the Debt Ceiling. Unfortunately, politicians seem to almost never make unpleasant decisions until forced to do so.
Interestingly, even as equity markets dropped during the last week of July, the capital markets continue to place significant trust in U.S. Treasury securities when you consider the level of where these securities are trading. Yields on these securities are very modest and continue to reflect very little expected impact related to possible outcomes. Recent new issue offerings continue to have more demand than available supply. Investors continue to have faith in the US Treasury market due to its size, credibility, and liquidity as a “safe haven” for many years. At this point, there are several problems around the world (debt crisis in Euroland, etc.) which limits what investors might consider as alternative options for investment. All of these factors are at work to help keep prices on US Treasury securities in check. While we have recently observed very slight increases in yields for the US Treasury bills maturing in August, it is miniscule. Investors have been trying to shrug off the possibility that the US would enter into a “technical default” but as the hour draws nearer to the announced deadline date, anxiety is apparent and progressively increasing as each day passes without a final resolution.
Most observers continue to expect that the Debt Ceiling issue will be resolved in the final deadline hour, if not sooner, and that when it comes to this issue alone, the US government debt markets will continue to operate as designed and all scheduled payments will be made as planned.