Debt Ceiling Debate – Considering the Alternatives

One of the biggest concerns for investors right now is the looming “X-date” as we approach the U.S. debt ceiling limit. In the unlikely scenario that a deal to raise the ceiling is not made, what would be the ramifications of a U.S. debt default? Truthfully, no one knows, however examining what might happen to other investments could help guide investors towards making informed decisions.

As a refresher from our last post (The Debt Ceiling Debate) the “X-date” is the estimated date at which the U.S. Federal Government can no longer pay its bills, including U.S. Treasury securities. In a recent letter to Congress, U.S. Treasury Secretary Janet Yellen said that the agency may be unable to meet all of its debt obligations as soon as June 1 if the debt ceiling is not raised.

The most recent and notable example of debt limit negotiations occurred in 2011. That was also a period of extremely harsh rhetoric and a lack of cooperation in congress until it was nearly too late.  At that time, according to the transcript of the Federal Open Market Committee conference call in August 2011, it appeared the U.S. Treasury prioritized principal and interest payments on U.S. Treasuries over payments of other obligations such as Social Security, Medicare, veteran’s benefits, etc. Just because the Treasury acknowledged prioritizing funds to ensure U.S. Debt would not default if the debt ceiling was not raised, does not mean this time will be the same, however that period and policy can be used as a proxy for what could occur in a few weeks.

Granted we are in a different economic environment compared to 2011.  At that time, the economy was showing signs of recovery from a recession caused by the credit crisis of 2008-2009.  Today we find ourselves in an inflationary period, fueled by pandemic era stimulus, and amid the Fed seeking to slow the economy by recently hiking rates at the quickest pace in 40 years. The chart below depicts the yield of 1-year U.S. Treasuries, of which you could see the significant drop in yield (shaded region) right after a deal was made on the debt ceiling on July 31, 2011. Seemingly, investors piled into “safety” once a deal was made. This is not to suggest 2023 will be a repeat of 2011 but to reiterate the prudent decision of staying the course and ignoring the noise works.

US Treasury Securities

With the “X-date” quickly approaching, a common question of investors who hold U.S. Treasury obligations is: what should I do (if anything) with my U.S. Treasury investment?

Let’s look at the alternative investments landscape:

Cash –The Bureau of Labor Statistics just released that headline CPI data for the month of April 2023, which came in at 4.9%. Most banks offer interest rates well below the current inflation rate, resulting in a loss of purchasing power over time. Secondly, we’ve just witnessed the second, third, and fourth largest bank collapses in U.S. history (although the FDIC does insure $250,000 per depositor, per FDIC-insured bank, per account ownership category). Lastly, if we do reach a deal, a flood of demand and investment into U.S. Treasuries would bring down yields and the opportunity to lock in higher yields for longer will no longer exist.

Money Market Funds – investments in high-quality, short-term debt instruments, cash, and cash equivalents generally maintain exposure to short-term U.S. Treasury obligations.  Yield offered typically follow the Fed’s discount rate. Considering Money Market Funds very short-term duration, investors are not locked into a rate for a period of time. If the debt ceiling is not lifted and impacts the economy, the Fed could be forced to lower rates to stimulate growth.  If, or really when, rates fall, the yield on money markets will quickly follow. While U.S. Treasuries can be utilized as a short, intermediate, or long-term investment, money market funds are typically used for short-term cash needs and/or as a cash equivalent.

Gold – the current price of gold sits near record highs.  Gold is very dependent on supply and demand of the commodity. Unlike silver, which can easily be produced, gold cannot so easily be mined or created.  Since the supply of gold is generally consistent, pricing fluctuations depend far more on demand for the commodity. By the time an agreement is reached, and sentiment improves, it could be too late to sell gold and get back into the alternatives.  More fundamentally, the precious metal does not generate income, therefore does not benefit from the law of compounding returns.

Corporate & Municipal Bonds – corporate and municipal debt are subject to credit risk of the corporation or municipality, which traditionally is considered higher to that of the U.S. Government.  In this instance, it may seem like municipalities or companies are more likely to pay their debts, however in the event of a U.S. government default, the economy would surely take a hit.  This could cause stress on different areas, cities, or aspects of the economy and affect related debt as well.

While not a direct alternative to U.S. Treasuries, equity markets could very well be impacted…

Equities – continued volatility appears on the horizon in equity markets. Equities are considered far riskier versus U.S Treasury securities and do not guarantee principal. In 2011, the S&P 500 sold off 17% in just a few months following an 11^th hour resolution to the debt ceiling and subsequent downgrade of the credit quality of the U.S. Debt due to “weakened effectiveness, stability, and predictability of U.S. policy making”.  Another downgrade, during an already fragile economic period, could be negative for stocks in the short term, although create an attractive entry point for long-term investors. Equity risk premium essentially states that for taking this added risk of having our investments tied to corporate profits, investors should be compensated with higher returns over time.  In the event an agreement is reached sooner than expected, this could lead to positive returns, quickly.

This exercise of examining the alternative types of investments to U.S. Treasuries can be helpful.  Ultimately, understanding each individual’s goals is paramount to ensuring their financial future is successful. As we approach the “X-date” of June 1, the alternatives to a U.S Treasury do not appear attractive (in terms of safety). We find it likely that a deal will be reached in a matter of time.

All in all, we remain focused on investing for the long-term. Continuing to keep your investment portfolio in-line with your overall investment objective may prove to be the best decision.

As always, please do not hesitate to contact your wealth advisor with any questions or concerns.