As if elected officials in Washington needed any more reasons to point fingers at each other, Jan. 19 brought the sticky subjects of government expenditures and excessive deficit spending back to the fore.
On that date, in the aftermath of pandemic-related spending, considerable additional spending commitments and an inability to pass meaningful tax increases, the government hit its credit limit, setting off a flurry of threats, accusations and political posturing.
More precisely, on Jan. 19, debt issued by the U.S. government reached its $31.4 trillion statutory limit, effectively ending the federal government's ability to borrow more funds to pay its bills. Until the so-called debt ceiling is lifted, the flow of federal government payments for Social Security benefits, veteran's benefits, family support payments, interest payments on outstanding debt and several other programs is at risk of ending.
"It is hard to see the current rate of spending and debt accumulation as being sustainable over a longer period of time, but the spending decisions that got us here were made through the appropriate process and, as such, should be honored," said Steve Wyett, chief investment strategist for BOK Financial®. "Yet, for all the political theater that we'll likely see over the next few weeks and months, the risks of inaction are far too high.
"Therefore, we do expect this latest debt ceiling challenge to be resolved."
Wyett added that expected higher interest rates from the U.S. Federal Reserve, including the 0.25% hike on Feb. 1, must factor into the conversation, as they'll further push the cost of debt higher.
"The math of the debt we have is changing and will be an issue for us going forward," he said.
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The authorized amount of debt the federal government can issue has increased almost five-fold since it reached $6.4 trillion in 2002.
A long-standing political hot potato, the limit has regularly been pushed, prodded and played by both Republicans and Democrats. In fact, in 2011, bond rating agency S&P Global cited "political brinkmanship" as one of its reasons for downgrading the U.S. bond rating from AAA to AA+.
More recently, the debt limit was suspended for two years between July 2019 and July 2021, a move that ended up allowing for a prompt fiscal response to the onset of the pandemic.
"Along with the Federal Reserve's efforts, that spending was, for the most part, successful in limiting the pandemic's damage to our economy, but we now have to face the bill for all of the borrowing we did while continuing the needed support for many moving forward," Wyett said.
In announcing the government's latest bounce off its credit limit, Treasury Secretary Janet Yellen urged Congress, which is responsible for overseeing and setting the debt limit, to resolve the debt ceiling issue rapidly. In the meantime, she said her department can avoid a default until early June with so-called "extraordinary measures," or accounting maneuvers that shift, delay or stretch out payments.
Historically speaking, spending drives credit needs
The first debt limit was established by Congress in 1939 was set at $45 billion. The first threat to a potential default due to Congressional delays surfaced in 1979, and the Treasury Department first utilized "extraordinary measures" to avoid default in 1985.
Away from the headlines, Wyett suggested that while the debt limit debate must be monitored, it's a symptom of the growth of government spending, which is higher than it was prior to the pandemic, when measured as a percent of the U.S. economy.
Wyett added that mandatory programs such as Social Security, Medicare and Medicaid account for about two thirds of the government's spending while discretionary spending, which includes outlays for defense, veteran's benefits, education and the climate policy, among other needs, takes up the balance.
"Congress can reduce the debt needed going forward by cutting spending or increasing taxes, neither of which looks possible at this time," he said. "But make no mistake, doing nothing and causing the economic chaos that would result from a default is not in anyone's best interest."
Practical realities should prevail
Until Congress negotiates the path forward, investors can expect occasional periods of market angst, especially as the Treasury's drop-dead date nears. In 2011, for example, a divided Congress sparring with the Obama administration over government spending led to bouts of market turbulence and the S&P downgrade, although the longer-term impacts were minimal.
Given that context, Wyett is advising clients to maintain the current approach to their portfolios and potentially take advantage of price changes that are unwarranted yet represent potential opportunities.
"I expect it to be an exhausting process, but in the end, I believe we'll see some sort of spending and tax agreement that allows both sides to claim a partial victory and claim they kept the economy from devolving into chaos or the U.S. government from defaulting on its debt," he said.
"Congress can't ignore that millions of people rely on timely payment of benefits and bond investors worldwide rely on the certainty of Treasury cash flows, so any interruption could cause significant disruptions in the Main Street economy of the U.S. and the global capital markets."