On October 12th, the U.S. House of Representatives approved legislation that temporarily raised government borrowing limits to $28.9 trillion. This action has staved off the prospect of debt default until December.
President Joe Biden will sign the measure into law before October 18th, which is the day the Treasury Department calculated it would no longer be able to pay U.S. debts without congressional action.
But how did it get to this? And what does this mean for the broader economy and U.S. stocks?
What is the U.S. Debt Ceiling?
Late September and early October 2021 have been anxious times for the U.S. economy. Congress faced a tricky task: reach a deal on the U.S. national debt ceiling, or the government would run out of money to pay its bills. Failure to do so could lead the U.S. to default on its debt, which has never happened before.
While this prospect has been put off until December, a solution needs to be found. So far, Republican and Democratic lawmakers have been at odds over raising federal borrowing limits, also called the debt ceiling.
Before the temporary agreement, the debt ceiling stood at $28.4 trillion. However, the national debt, which is the total that the government owes creditors, was $28.43 trillion.
With the October 18th deadline looming, a stopgap bill was required to prevent the first default. Failure to reach an agreement would have meant that the federal government would default on its obligations, including Social Security and payments to veterans.
The debt crisis was causing some nervousness in the U.S. markets. Republicans had been expected to block a third attempt to raise the debt ceiling. However, fears eased slightly once Mitch McConnell, the Senate Minority Leader, indicated his party would support the debt ceiling extension into December. Additionally, McConnell’s announcement caused yields on one-month Treasury bills to drop.
What Would Happen If the U.S. Defaulted?
Congress may have kicked the debt ceiling down the road for now, but an agreement still needs to be found. Otherwise, the U.S. faces the prospect of a government shutdown.
Stock investors won’t be delighted about this prospect. Several headwinds are swirling at the moment, like Federal Reserve tapering. Analysts at Goldman Sachs have suggested that shutdowns don’t necessarily spell bad news for the market. However, several other factors could affect stocks.
Goldman’s analysis shows that government shutdowns have historically failed to have a meaningful impact on equity returns. There have been 14 government shutdowns since 1980. During these shutdowns, the S&P 500’s median returns were: – -0.1% on the day of the shutdown – 0.1% during the shutdown – 0.3% on the day of the resolution.
The only exception was the most recent shutdown during December 2018. During this time, the S&P 500 dropped by 2%. However, as Goldman notes, this decline was more likely driven by investors’ fears about Fed tightening.
While budget expiry doesn’t have a considerable effect, debt limit deadlines do affect some parts of the market. Government revenue exposed stocks — like industrials and health stocks — underperformed the market during the 2011 and 2013 debt limit deadlines.
If the government can’t find a debt ceiling solution by December, these stocks could be affected again.
What Else Could Rattle Equities?
Goldman strategists suggested that the macroeconomic picture is a better predictor of how the equity markets would respond. During the 2011 and 2013 debt limit shutdowns, the S&P fell in 2011 but rallied in 2013.
The big difference between these two was the broader economic situation. In 2011, there was declining economic growth, the S&P had downgraded U.S. sovereign debt, and the European debt crisis. By contrast, the conditions in 2013 were more favorable.
The macro picture is causing some concern heading towards the fall. Global markets rose last week as the U.S. waited for Labor Department data. However, it don’t can’t doesn’t investors ‘500’s Goldman’s here is hope for the broader economy.
Historically, debt limit deadlines don’t have a significant impact on the S&P 500. However, some caution is the market should be expected if Congress struggles to reach a more permanent solution to the borrowing limits problems. For now, though, the biggest fears for equities come in the form of the energy crisis, Fed tapering, and concerns about GDP.
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Alpesh Patel OBE