How Does the U.S. Debt Ceiling Affect Investors?
As the U.S. faces a new debt ceiling crisis, investors seem to shrug off fears as similar circumstances have implied that Congress will likely blink at the final hour and increase the limits. The amount of debt the government has lent is further challenged by higher rates and inflation, and the daily life of financiers, investors, and citizens should feel more hindered in the current economic environment.
In January, the U.S. technically reached its debt limit ceiling; however, The Treasury Department announced that it could continue to pay the bills using “extraordinary measures” until early June. The federal debt stands at an astonishing 31 trillion dollars, putting the burden of 94 thousand dollars on every American citizen.
The U.S. government has taken precautions to extend, revise, or permanently change the debt limit 78 times since 1960. Now as Biden looks for a solution with no loose strings, the probability of a never before seen default-on-debt situation could be presented in the capital’s palms. Members of Congress, bankers, and economists have debated this frightening anomaly.
The question is, what happens now if the debt ceiling is violated?
3 Ways Investors Will Get Affected by a Higher U.S. Debt Ceiling
1. Greater Borrowing Costs
As the country’s financial crisis ripples down on all American citizens, an appreciable increment in interest rates will be observed. In the government’s effort to borrow more at higher interest rates, longer-term borrowing costs will hike across all markets, putting your investment planning at grave risk.
This interest rate is inversely linked to stock market values, one of the most volatile markets that guide the pathway for investors. Once borrowing costs are high, companies will borrow less money to bear fewer costs. Hence, their anticipated growth rate is lower than investors would ideally want.
Simply put, the present value of the future forecasted stock returns is reduced. This means investors could not make keen valuation insights and predictions before selecting companies to invest in.
The greater risk that comes with higher interest rates is off-putting news for investors.
If you’re looking to invest somewhere, you will now require diversified portfolios and careful approaches toward the market before making decisions.
Tip: A short-term pacifier may include foreign stocks.
2. Less Appealing Bonds
The U.S. government is likely to resort to treasuries to cover the deficit, pushing longer-term interest rates higher.
With the delicate economic conditions, interest rates are bound to rise as previously mentioned, and hurt the steady treasury incomes.
Treasury bonds, considered low-risk investments, will now carry greater risk because their monetary return has a lower real value.
Under normal circumstances, this may not be a significant issue. However, considering the debt ceiling problem, interest rates may keep rising long-term and put investors in a loop of credit risk.
This is because the ‘issuer’ of these bonds or the government may reach default before the previously purchased bonds reach their maturity.
Overall, bonds’ simplicity and risk aversion are lost, and investors may have to explore different options until the debt ceiling problem looms.
3. Debt Out of Your Pockets
Until the U.S. government decides whether to raise the debt ceiling, uncertainty in markets will prevail. Assume this volatility will rise as the June deadline approaches unless a compromise is announced.
Rising risks in investments, however, are not the only financial quandary investors will face. As we previously mentioned, a certain amount of debt floats over every citizen, and investors are also subject to this.
With debt covering a chunk of their pockets, investors will have lesser amounts left to invest. Therefore, the money circulated in different markets takes a hit and worsens the conditions of return and reward.
If conditions prevail, investors may no longer rely on market ratings and financial analysts but instead look to other sources of income, such as corporate bonds or preferred shares.
These issues may be resolved if the government extends the ceiling or takes another course of action.
They should approach the markets with a long-term mindset rather than reacting to every short-term change and event.
As markets and investors flail about anxiously, it’s still uncertain whether the U.S. will default. History teaches us that Congress always manages to draft a solution before the U.S. faces economic ruin.
Generally, markets become increasingly more volatile during the final week and days before the decision is finalized. However, once an agreement has been reached, the treasury bonds have historically bounced back quickly, so investors should be wary of timing any bearish short-term plays.
Investors can resort to lower-risk assets and find less volatility in short-term treasuries. The bottom line is that several other restricting economic factors currently loom, so a careful approach toward the bonds markets is the best way to go for the coming months.
Josh is a financial expert with 15+ years on Wall Street as a senior market strategist and trader. Josh graduated from Cornell University with a business degree in Applied Economics and has held numerous U.S. and European securities and brokerage licenses including FINRA Series 3, 7, 24, & 55. In addition to running an investment and trading firm, Josh is the founder and CEO of Top Dollar, where he teaches others how to build 6-figure passive income with smart money strategies that he uses himself.