Through the roof? The perils of the federal debt ceiling

The United States is approaching a significant fiscal deadline in June: The debt ceiling, the maximum amount of money that the federal government can borrow to meet its financial obligations could be breached as early as June 1.

If the government reaches the debt ceiling without a resolution, it will be unable to pay its bills, potentially leading to a government shutdown or even a default on its debt. The last time this came close to happening was in 2011. The impact  caused a downgrade in the U.S. credit rating and shook global markets.

“In January, we brushed up against that debt ceiling, and ever since then, we’ve been utilizing extraordinary measures, incoming tax receipts, and that has allowed the government to avoid default, and that can only go on for so long,” Charlie Dougherty, director and senior economist at Wells Fargo Corporate & Investment Banking, said. “There’s a date that nobody knows–It’s in the future. It’s called the ‘X-date’ and once you hit it, once the debt ceiling is not raised or suspended, you could potentially default on that debt.”

The Treasury Department has been taking “extraordinary measures” to avoid reaching the debt ceiling, such as delaying investments and tapping into emergency funds. However, these measures can only last for so long, and the clock is ticking. In addition, some lawmakers are using the debt ceiling as a political bargaining chip, with Republicans refusing to raise it unless Democrats agree to spending cuts.

“When you look at the makeup of Congress, the White House, the House of Representatives and the Senate–It looks a lot and feels a lot like 2011, which had a similar political makeup,” Dougherty said. “That was also the last time that we came so close to sort of exhausting our borrowing capacity. I think if you look back at that experience, it had a number of economic consequences.”

In 2011, the U.S. saw the stock market generally decline and in the few months before the debt limit was ultimately increased, bond prices suffered, which means interest rates moved up.  

“You had consumer confidence turn lower, and as you know, more publicity about the U.S. potentially defaulting became known. But ultimately, it was raised but that something was raised and there was a temporary solution,” Dougherty said. “I think it’s still the most likely scenario but the risks of that not happening are certainly elevated and probably rising, given the political backdrop.”

What could happen in Idaho?

A government shutdown or default would not only impact the U.S., but also have global repercussions. The uncertainty around this issue is already affecting the bond market, with investors demanding higher yields to compensate for the risk. As the deadline approaches, the pressure is mounting for lawmakers to come to a solution before it’s too late.

If we do hit the “X-date” without a resolution, The Treasury could attempt to prioritize principal and interest payments in order to prevent a technical default, Dougherty said.

Even Social Security, Medicare, defense spending and military pay could be considered for cuts by the Treasury if Congress doesn’t agree to a hike in the debt ceiling,.

“There has been a lot of macroeconomic uncertainty following the pandemic–you’ve got inflation and you’ve got higher interest rates. I think this whole debt ceiling negotiation ultimately just adds that uncertainty. And at a local level, it could negatively impact consumer confidence and there would be volatility in the financial markets. But overall, we’re all speculating here because it’s never really happened yet.”