Debt Ceiling Update

Debt Ceiling Update

(as of Friday, May 5, 2023)

In light of recent developments surrounding the U.S. debt ceiling, we want to take a moment to discuss the potential impact it has for our investments. We are working hard to be as defensive as we can and not chase many of the stocks we feel are at nosebleed highs. Hershey’s is one of those companies. We learned long ago that a market lead by chocolate isn’t to be trusted. On May 1, the Treasury Secretary alerted Congress that if the debt ceiling is not raised by June 1, the U.S. could default on its debt.

While not entirely unexpected, the situation does warrant close attention. The U.S. reached the debt ceiling back in January but managed to delay its consequences through “extraordinary measures” — a set of accounting tools that allow the government to pay its bills without issues new debt. These measures are nearly exhausted, and without a debt ceiling increase, the U.S. won’t have the funds to fulfill its obligations. The exact date of this potential is uncertain, but the earliest estimate is June 1.

A default could have serious economic repercussions, but even the mere possibility of one can negatively affect the markets. To understand why, let’s take a quick refresher on what the debt ceiling is. The debt ceiling represents the maximum amount of money the government can borrow to meet its existing legal obligations, such as Social Security, Medicare, tax refunds, military salaries, and interest payments on Treasury bonds.

In normal circumstances, raising the debt ceiling is a straightforward process. However, political disagreements on whether to raise it without an accompanying decrease in spending have led to a fiscal standoff. Republicans demand spending cuts, while democrats prefer a “clean” hike without conditions, arguing that changes to federal spending should be addressed separately.

This game of political “chicken” has real consequences. While we can’t predict exactly what will happen if the U.S. defaults (it’s never happened before), we can look to history as a guide, and it’s the only guide we have. Since 1960, the debt ceiling has been raised 78 times. (Yes, sometimes more than once per year.)

History has shown us that similar debt ceiling crises have been resolved in the past. However, the current divide between Democrats and Republicans remains significant, and an upcoming meeting on May 9 may not necessarily lead to a resolution. We believe the U.S. won’t default on debt payments and a resolution will be passed to allow for the debt payments to continue, but will postpone the spending debate into next year’s presidential campaign.

As June approaches, Wall Street’s anxiety will likely increase. The markets are already grappling with uncertainty due to rising interest rates and recent bank failures, so a debt ceiling crisis is an unwelcome development. We believe Congress may opt for a short-term increase to the borrowing limit. The U.S. could continue debt payments, so we don’t default on our obligations. But would only delay the issue rather than provide a lasting solution by adding fuel to the presidential campaign in 2024.

In the event of a default, there may be ways to mitigate the damage, such as prioritizing debt payments or having the Federal Reserve purchase more Treasury bonds. Nevertheless, these are far from ideal solutions, and it’s in everyone’s best interest to avoid them.

Rest assured, our team is closely monitoring the situation. If any changes to your portfolio are necessary, we’ll information you right away. We’ll also keep you posted on further developments and provide more detailed information on the potential implications for investors.

As always, please don’t hesitate to reach out with any questions or concerns. Our team is always here to help.