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Still No Resolution on the Debt Ceiling

A month and a half has passed since the U.S. hit the debt ceiling in May and an agreement still has not be reached to raise it. There is an obvious concern over what would happen if a debt ceiling increase deal is not completed by August, and the reverberating impact it would have on the global financial markets. First, the risk is currently that rating agencies will downgrade US debt to “selective default” if the U.S. misses a debt payment in August. That means US debt maturing on August 4 would be rated “D.” This could also lead to a possible downgrade of overall US debt, that would be felt throughout the financial system, which is the fear the news is reporting.

It is important to step back out of the media spotlight and consider a couple more important points. The first, and usually the most timely barometer, is how the global market has reacted to the news. Over the past five days the market has steadily increased and is up 5.5% for its best week in two years. Also, the current yield on the 10 year Treasury was near its lowest point of the year last week, and is still well below where it began the year. If there was grave concern over the future of U.S. Government debt, the yield would have climbed significantly higher by now. This has all happened while the debt ceiling limit is fast approaching. Another point is that the US Treasury also has additional tools at its disposal to take extraordinary measures to forestall a default on US debt, without the debt ceiling being raised by congress. Although these tools do not come without significant long term side effects.

Judging from the consensus opinion of analysts around the globe, the market has reviewed the problem, analyzed the potential impact, and concluded that the probability of the US not reaching an agreement eventually is low enough not to offset other positive economic news (manufacturing growth, Greece passing austerity measures, and other economic figures that were better than expected). Although the current politicizing of the debt ceiling is much akin to playing chicken with a racecar, it is still important to review what the collective voice of the market is telling us. The sky is not falling.

We continue to remain confident in U.S. Government bonds and we do not recommend making any changes in your portfolios at this time.