You're going to hear a lot about the "Debt Ceiling" over the coming weeks. Here's what it means in 5 minutes or less:
1. What is the debt ceiling?
It’s the amount of money the US has to pay its bills, which is authorized by the Treasury. Government spending exceeds government revenue (big surprise), so the Treasury issues debt to cover the shortfall. However, there’s not an endless amount of issuable debt, thus a “debt ceiling” is imposed. Congress typically votes to move the ceiling higher, allowing more debt to be incurred. The debt ceiling covers Medicare & Social Security, as well as military salaries and other items.
2. How common is a debt ceiling increase?
Extremely common. Every single President dating back to Eisenhower has increased the debt ceiling at least once, while Reagan’s term alone saw 18 increases. There have been a total of 89 increases since 1959. Increases occur under both Republican & Democratic presidents, as well as every combination of Congress. And get your popcorn ready, as I expect more political theatre and drama!
3. How likely is a deal?
It’s in the best interest of both Democrats & Republicans to reach a deal, and history shows that increasing the debt ceiling is a very likely outcome. Politicians are aware of the potential economic ramifications of a default, and neither side will benefit from more market weakness heading into an election year. Most of the experts that I follow suggest the 90th debt ceiling increase will occur, and I fully agree.
So there you have it- a crash course on the topic that will dominate the headlines until mid-June. In my career, only 1 out of the 20 debt ceiling increases/debates triggered a meaningful selloff. It was the summer of 2011, and the US debt's credit rating was downgraded by S&P (the rating agency). The market dipped about 19% from peak to valley, but still managed to finish the year slightly positive. So it's safe to expect some volatility, but nothing unusual.