The debt clock is ticking louder.
The nonpartisan Congressional Budget Office recently revised its projections for federal revenues and expenses.
According to the CBO there is now “significantly greater risk that the Treasury will run out of funds in early June”.
Treasury Secretary Janet Yellen said on May 1 that the US government could become unable to pay its bills as soon as June 1 if Congress doesn’t raise the debt limit soon.
These new estimates set a shorter timeline than many experts previously had been forecasting.
House Republicans approved legislation last week that would raise the borrowing limit for about a year, but parts of the legislation are unpalatable to Democrats.
In other comments she’s made recently, Treasury Secretary Yellen is not mincing words: “A default on our debt would produce an economic and financial catastrophe. A default would raise the cost of borrowing into perpetuity.”
President Biden has called top lawmakers from both sides of the isle to the White House for a meeting on May 9 to try to forge an agreement for a debt limit increase.
The situation remains tenuous, with extremely high stakes. As investors, how should we think about this?
The bond fund manager PIMCO has a group of researchers dedicated to understanding how public policy impacts financial markets, and they recently shared their thinking on the debt ceiling.
Here are some takeaways on the debt ceiling issue from a recent PIMCO note:
- More than 70% of Americans support avoiding a default, even without spending cuts – according to a recent CBS News / YouGov poll
- Because popular sentiment supports raising the debt ceiling, default is not a political winner, and leadership on both sides of the aisle know this
- If past is prologue, a resolution will likely happen at the eleventh hour and only after some brinksmanship
- The average peak-to-trough performance of the S&P 500 in the month before a debt ceiling resolution over the past dozen years has been about -6.5%
- A debt ceiling deal is the most likely outcome
From my perspective, it is inadvisable to significantly alter long-term investment strategies designed to support long-term financial plans, in anticipation of political events, especially those that have a low likelihood of transpiring.
The key to managing through possible larger-than-normal stock and bond price swings is to hold enough in liquid reserves (cash and short-term investments like money markets and short-term bond funds) to meet your near-term cash needs.
RK