Are We Facing Another Debt Ceiling Debacle?

Two issues are about to collide in Congress at the end of this week: the looming threat of the ever expanding national debt and the end of the federal debt ceiling suspension on July 31.

Either the federal debt ceiling is raised to accommodate more government debt (and spending), or the debt ceiling is enforced, limiting the amount that the government can borrow, potentially impacting the current White House administration’s plans for further infrastructure and other stimulus spending.

Before we go further, let’s do a recap of the basic concepts at stake.

The national debt is the amount the federal government owes its creditors, and right now, it’s standing at $28 trillion, roughly 128% of US GDP, according to the US Debt Clock.

The federal debt ceiling is the maximum amount the government can borrow by issuing bonds. The debt ceiling has been suspended several times, on and off, since 2013. When the Covid pandemic struck in 2020, it began its longest suspension, as emergency stimulus spending aimed at economic recovery took priority over fiscal conservatism.

What Are the Big Issues?

The alarming headline that’s the least likely to happen is that the federal government runs out of money by October or November. This would shut down the federal government, and it’s highly unlikely to happen.

The issue concerning the national debt is that it’s ballooned to record-levels. Remember, the government doesn’t generate revenue the same way companies do. It generates revenue through taxation. So, if “we” owe $28 trillion, that amounts to over $226,790 per American  taxpayer. And it’s growing. If the federal debt ceiling is raised or suspended, more Treasury bond issuances means higher payments in the future.

This leaves the government with only two solutions: inflate the money supply (via the Federal Reserve) or increase taxes. Either way, the solutions reduce purchasing power. So an increase in the national debt is technically a claim on the future income of its citizens.

This is the basic principle driving the debate.

Another headache the federal government is currently dealing with is that it has a balance of $700 billion on its Treasury General Account, which is far above its target of only $450 billion by July 31. This would keep its balance sheet near the top of its limit should the debt ceiling come crashing down from its virtually sky-high suspension. How the government will reduce its balance sheet can cause havoc in the money markets (but that’s another complex issue that we’re not going to talk about right now).

How Might the Coming Congressional Showdown Affect the Markets?

Whether the debt ceiling is raised, suspended, or enforced, you can expect a very fluid situation with many variables depending on the behind-the-scenes negotiations taking place in Washington. Furthermore, you can expect that inflationary data, job market data, and delta variant data will all come into play in these negotiations. In short, expect lots of uncertainty. This means potentially extreme market volatility.

By the way, if you don’t already understand the issues surrounding the current inflationary debate (and you really should know something about this as a trader), then read GFF Brokers CEO Greg Khojikian’s insightful Forbes article on the inflation debate.

If the debt ceiling isn’t raised and the federal government runs out of cash, it will have to operate on a cash-flow basis, meaning that inflows such as tax receipts and fees will have to fund its outflow payments (namely, interest payments on debt).

This means that the government will have to prioritize payments among several programs including Social Security, Medicaid, state unemployment benefits, military salaries and operating expenses, and government salaries and operating costs. This may negatively impact various private sector industries involved with any of these governmental segments. Ultimately, a disruption in sectors or industries can weigh upon markets as it’s likely to have a domino effect on companies, jobs, and households.

If the government fails to negotiate on an agreement, as was the case in 2013 when Uncle Sam was just days away from default, America’s credit rating can be downgraded, forcing the government to raise interest rates to sweeten the pot particularly for global investors looking for stable yield from a reliable issuer. A downgraded credit rating can also affect corporate bonds, as the country as a whole may be deemed riskier by international credit standards. Such a scenario can negatively affect corporate profits, perhaps prompting them to raise prices to compensate for the higher interest it must now offer in its bond issuance.

If the debt ceiling is raised, then we can expect the national debt to grow even larger. Ultimately, this debt has to get paid, by taxes or money supply inflation. The federal government may proceed with its infrastructure spending, requiring more Treasury bond issuances (expanding the national debt even more), much of which may come from Federal Reserve asset purchases (further increasing the money supply and…you guessed it…inflation).

What You Can Do to Position Yourself as a Trader

Following the blow-by-blow action of negotiation and resolution takes a lot of work. If you want to follow each step and try to forecast its effect on anything from government to corporate bonds, money markets, sectors, and industries, then by all means go for it.

Expect lots of volatility that may present either strong momentum trading opportunities or (if you’re an investor) rebalancing opportunities. If you trade futures, you’ll have to follow the news if you want to take advantage of very specific situations in the market, particularly when it comes to specific sectors and industries.

Remember that there are two (sometimes opposing) factors at play: market fundamentals and market sentiment.

Should Consumer Price Index (CPI) or Personal Consumption and Expenditure (PCE) indicate that our supposedly “transitory” inflation might turn out to be “persistent,” then it’s important to watch what’s happening in the gold market versus, say, the TIPS (Treasury Inflation Protected Securities) market, or even the Bitcoin market (which might have failed its first test as an inflation hedge).

Pay attention to what big banks and investment firms are saying versus doing. For instance, BlackRock just invested $1.4 billion of its model portfolio funds into a single TIPS ETF. What does that say about their inflationary expectations?

Should the White House infrastructure spending bill move forward, which commodities might benefit? Might silver–both a monetary, industrial, and green energy-related metal benefit in either scenario?

The Bottom Line

There are many markets, sectors, and industries that may be affected by the coming debt ceiling negotiations. If you seek market opportunities related to this major policy event, then pay attention to everything that’s going on in Washington regarding the negotiations, try to determine how markets are responding to the event, and pay close attention to what large financial institutions are doing in response to it.



Please be aware that the content of this blog is based upon the opinions and research of GFF Brokers and its staff and should not be treated as trade recommendations.  There is a substantial risk of loss in trading futures, options and forex. Past performance is not necessarily indicative of future results.