US debt-ceiling debate heats up again

Once again, Congress and the White House are wrangling over an increase in the debt ceiling. The stakes are high. Failure to do so would lead to a default on the federal debt, which could have far-ranging economic consequences.

If history repeats, a deal will ultimately be reached. In the meantime, political uncertainty could disrupt financial markets—and also create investment opportunities. Says Lars Schuster, institutional portfolio manager in Fidelity’s Strategic Advisers group: “It’s unnerving to see these headlines. The good news is that historically volatility in the markets tends to be fairly short-lived. This could result in a good buying or portfolio rebalancing opportunity for long-term focused investors.”

What is the debt ceiling?
The federal debt ceiling is a limit set by Congress on the amount of money that the US Treasury can borrow to fund the government’s operations and make interest payments to the people and institutions who own US government-issued bonds. Since the ceiling was reached in January, the Treasury has relied on so-called extraordinary measures to keep operating until Congress reaches an agreement for a debt limit increase. If the debt ceiling is not raised, the Treasury would be unable to issue more Treasury securities and the nation could default on its debt, potentially by June.

Since 1985, the Treasury has had to resort to extraordinary measures 11 times and each time Congress has acted to forestall default, though often at the last minute after considerable high-stakes wrangling. Alice Joe, vice president for Federal Government Relations, says neither party in Congress views default as an option, but the highly partisan environment is making it harder to reach an agreement to extend the debt limit than has been the case in the past.

The possibility that the Treasury could run out of money may cause some short-term volatility in financial markets and the flurry of fear-inducing news stories that often accompany choppy markets. As the chart below shows, markets have historically risen on average in the months following an agreement to raise the debt ceiling.

The debt ceiling has, in the past, spurred contentious and prolonged debate about fiscal responsibility and the growing national debt.

In 2011, the disagreements went so far that the credit rating agency Standard & Poor’s downgraded the US credit rating to AA+, one step below the best rating of AAA. Standard & Poor’s cited the growing deficit and the prolonged debate as reasons for the downgrade.

Historically, raising the debt ceiling has not been a battle legislators want to fight. Administration officials usually work behind the scenes to convince legislators of the importance of raising the limit relatively quickly and without fanfare. This approach helps limit financial market uncertainty, minimizing the potential for government borrowing costs to increase amid a debt-ceiling debate, while reducing investor concerns.

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