Dealing With the Debt Ceiling

Congress last raised the debt ceiling in 2021 to its current level of $31.4 trillion.

The US government hit the debt ceiling earlier this year, leaving consumers with questions about what happens next.

Our colleagues in Goldman Sachs Asset Management have some insights into the process and the potential risks if the path forward remains unclear.

The debt ceiling process and timeline

January – March. The US federal debt level officially hit its $31.4 trillion debt ceiling in January, forcing the Department of the Treasury to begin using “extraordinary measures” to fund the government.

Extraordinary measures included selling non-marketable (not bought or sold on public exchanges ) US Treasuries currently held in federal employee retirement funds and suspending additional contributions. All securities are expected to be replaced once a resolution is reached, meaning there should be no lasting impact on any retirement funds.

March – May. The Treasury exhausted most of its extraordinary measures in March and began to use its cash balances, which were estimated to be nearly $500 billion at that time. The cash balance changes as the flow of tax receipts weakens or strengthens, affected by the course of economic growth.

May – Summer. The Treasury has said it may run out of cash by early June, though higher-than-expected tax receipts could push this deadline to late July. Either way, uncertainty remains high, and time is running out.

Before all of the Treasury’s cash is exhausted, Congress will need to raise or suspend the debt ceiling to avoid defaulting on its debts.

Potential impacts

Regardless of the outcome, a lengthy resolution process may ultimately cause market volatility and risk an abrupt re-rating of US Treasuries.

If no resolution is reached, the Treasury could be forced to keep the federal debt at the limit by paying out only as much as they are currently taking in. That would require significant spending cuts. Forced spending cuts of this magnitude could materially change the economy, consumer confidence and the financial markets.

GS colleagues don’t expect the US to default on its debt. Even if the debt ceiling isn’t lifted in time, they believe the Treasury is likely to prioritize debt principal and interest payments. The markets might interpret this type of hypothetical, technical default as more of a political event than a black mark on America’s credit. If so, this could soften any long-term impacts on federal borrowing.

History suggests market risks could rise

In 1979, a breach of the US debt limit left the government temporarily unable to cover its bills, leading to a technical default and a surge in short-term rates. This case was quickly resolved after an increase in the debt ceiling, and confidence in the full faith and credit of the US government was restored as lenders were paid back.

One of the more consequential debt ceiling breaches occurred in 2011. Rating agency S&P downgraded its credit rating for the US, and the VIX (a popular measure of stock market volatility) spiked to its third highest level in the past 15 years (only the 2008 Global Financial Crisis and the start of the COVID-19 pandemic pushed it higher). Investors saw a -16% drawdown in the S&P 500 between July 22 and August 10.

This time around, if the debt ceiling isn’t raised or suspended before the deadline is reached, our colleagues expect the greatest impacts to be on 1) US Treasuries maturing around the time the debt limit is breached, 2) stocks sensitive to government spending, and 3) asset prices exposed to rising borrowing costs.

Overall, they believe market volatility is likely to remain high, as this issue and other sources of uncertainty persist in the economy.