How The US Debt Ceiling Debacle Impacts Investors
By Space Coast Daily // May 17, 2023
The United States is currently facing a debt ceiling crisis that threatens to disturb the US economy and impact investors around the globe.
The looming deadline in early June to lift the $31.4 trillion borrowing limit, else risk a default on US debt, has the potential to cause a global economic recession.
Ramifications
President Joe Biden’s days are currently being spent trying to defuse the escalating debt ceiling crisis with Congress, but the stakes get higher each day. Biden is scheduled to meet with leaders from both parties with a goal of raising the ceiling.
A potential default could seriously harm the macroeconomy, but so is just the threat of one. This situation has led to increased volatility in the Plus500 US Futures market, which is sensitive to political events and economic uncertainty, particularly given its already-risky nature.
President Biden is keen to separate the debt ceiling problem from discussions about spending and budget negotiations. Of course, a default would have significant economic ramifications. It could mean interest rates further increase, would certainly damage the US’ credit score, and reduce confidence in the US economy – from both international and domestic investors.
The debt ceiling essentially authorizes the payment of pre-existing commitments. So, Congress must suspend or increase the limit if they want to pay their liabilities. The US has never defaulted on its debts, but experts highlight the likelihood that failing to raise the ceiling could cause a global financial catastrophe. Jobs and investments around much of the world would be impacted.
Risks involved for Investors
Beyond an unresolved debate, the debt ceiling issue is causing current treasury bill yields with imminent maturity dates are increasing. This is costing the US government more money, which of course reflects onto the taxpayers. It’s also not too dissimilar to the situation in the UK when the UK pension sector, Bank of England, and government were playing a 3-way game of chicken whilst the bond market was in crisis.
Stocks have fallen along with both business and consumer confidence. A new credit crunch is being whispered about, despite private credit being seen as preferable to equities for some investors. President of Queens’ College at Cambridge university, Mohamed El-Erian, recently stated that there is a likelihood – and assumption – of a last-minute deal being made.
Regardless of whether there is a default, it has already caused volatility concerns. Some investors have a wondering eye, looking at other currencies, commodities, along with foreign equities, property, and bonds as a way to hedge the risk.
Whilst it may not be isolated to the issue of the US debt ceiling, but Warren Buffett’s Berkshire Hathaway sold $13.3bn worth of stock and invested minimally in the US equity market in Q1 2023, signalling little appeal in a volatile market. Instead, $4.4bn of its own stock was purchased. With his recent statement claiming the Taiwan Semiconductor Manufacturing Company is one of the best managed firms in the world, he too could be looking outside of the US.
Opportunities for Investors
The debt ceiling concern is far from a novel problem. In fact, it’s become a regular occurrence. So, whilst the worst-case scenario is highly concerning, it’s not uncharted territory. This helps soothe confidence and certainty – two hugely important factors in market and economic behavior. Therefore, maintaining the long-term strategy is common advice.
Whilst there will be greater volatility should a deal fall through, it’s not the most expected outcome. As mentioned earlier, bond yields have increased, and whilst this is a threat to the government, it also has ramifications for investors in the US.
For traders, there are a plethora of strategies that seek to capitalize on volatility, either through arbitrage, high frequency trading, or simply taking short positions. Of course, a leveraged short position is a high risk, but it does mean opportunities may exist for those traders in the current climate.
In fact, those trading Futures may look to commodities and oversea equities anyway, as there can be both isolated trading opportunities and are of less systemic risk to the US’ situation. In either case, neither index investors nor Future traders should be too low on confidence, but should remain cautious and up-to-date on the situation.
The US debt ceiling crisis presents both risks and opportunities for investors. While it is crucial to remain cautious and aware of the potential consequences, there are still ways for investors to diversify their portfolios and protect their assets during these turbulent times. By staying composed and exploring alternative investment opportunities, investors can navigate the current debt ceiling debacle with both confidence and caution.
Overall, most analysts believe that a default is unlikely, but possible. This is also the mindset that investors should have towards the situation, because making a sure guess for either scenario would be reckless.
