Dancing on the Debt Ceiling

As talks come down to the wire (again), the debt ceiling limit debate continues to loom over the markets and economy. You could barely turn around last week without hearing all the dire predictions of what could happen if we don’t raise the debt ceiling and the catastrophic results of a potential default. But both parties signed that default isn’t on the table and a deal will be reached, which calmed markets somewhat as the week wore on.

Simply put, there is a limit on the amount of debt the government can issue. And since the government spends an increasing amount of money over time, the ceiling needs to be raised periodically so that prior commitments can be met. Whether you agree on what the government is spending its funds on or how much it loans itself is another matter. We are still in limbo right now because Congress and President Biden seemingly haven’t felt pressure to fix the problem until markets really seem to freak out — and that hasn’t happened yet because they probably believe our elected officials aren’t dumb enough to default on the government’s debt. The fact is we have gone from no compromise on either side to possibly getting a “workable deal” soon. In fact, the talks may be so far along that the president felt he could go to Japan on a state visit and return on Sunday.

Ironically, in this situation, demand for U.S. treasury bonds goes up, while prices rally and interest rates decline. These are the same bonds that will not be paid if the government defaults. In times of uncertainty, U.S. bonds are considered a safe haven, even when the uncertainty stems from the possibility of them defaulting.

We may still be on the brink of a default, and any slight miscalculation could potentially blow up in our faces. We waited this long to address the problem, but market volatility has seemed to be benign so far. Bond yields have only begun to tick up in the past month as markets grew more nervous. If the debt ceiling is raised in time, we likely will quickly forget about it until next time. If something crazy happens, stock prices could drop and bond yields could then spike — and that would not be a welcomed development.