Will the Debt Ceiling Come Crashing Down on the US?

On Tuesday, September 17, 2013, the S&P 500 ended the day at 1,704.76, up 0.42%; the Dow Jones Industrial Average closed at 15,529.73 up 0.23%; and the NASDAQ Composite finished at 3,745.70, up 0.75%. This has again brought the S&P 500 within 1% of its all-time highs of 1709.67. The rise in stock market futures demonstrates the market’s optimism that the Fed will not taper its bond-buying significantly, especially after the hawkish Larry Summers has withdrawn his nomination from the running for the post of the Fed chief.

While the markets are busy with the Fed’s meeting today, the crucial debate in Washington on the debt ceiling is taking a backseat. Treasury Secretary, Jack Lew, revealed on Thursday, that the US will touch its debt ceiling in mid-October, a few weeks ahead of the projected Labor Day estimate. A debt default by the US will have far reaching consequences since it will have a direct effect on businesses as credit will immediately dry up and the government might not be able to pay its employees. A default on debt will have a market impact much larger than anything the Fed will announce today.

Lew repeated an earlier warning that the government might run out of options by mid-October. The major problem may arise, according to Secretary Lew, in the debt roll-over that happens every week. Every week, about $100 billion of the Treasury’s debt matures and is invested back in it by market participants. If, at any time, investors want to cash in due to a lack of faith in the US government, Washington will have little room to maneuver and the largest economy in the world might then default on its debt.

The debt ceiling is the mandated amount of money that the US government is permitted to borrow to fulfill its current commitments, which include national debt interest, military salaries, tax refunds, Medicare and Social Security. It has existed in some form or the other since 1917 and the US is the only democratic country, other than the Denmark, to have legislative constraints on issuing debt. Originally, the debt ceiling was intended to provide Congressional oversight to curb any irresponsible expenditure by the government. However, in the last few years, this hitherto non-contentious topic has become a strategic game of political one-upmanship that unnecessarily worries the markets. It also threatens the US economy as defaulting could have far-reaching consequences for the real economy.

The last time the US government was close to reaching the debt ceiling and not increasing it, as it has since the Great Recession, was in 2011. A crisis was narrowly averted then with the creation of the Budget Control Act of 2011, which set a new ceiling for 31st December 2012. At that point, the US Treasury began using various extraordinary measures to prevent default.

Subsequently, President Obama signed a suspension of the US debt ceiling from February through May 19, 2013 — a temporary arrangement that permitted the government to carry on borrowing enough to cover its obligations till May. On May 19, the debt ceiling was reinstated at just under 16.7 trillion to accommodate borrowing during the suspension period and the Treasury began applying extraordinary measures. And now, once again, the debt ceiling crisis is looming up and Congress is folding up its sleeves for a fiscal head-to-head with President Barack Obama and the Democrats.

The $16.7 trillion debt ceiling has been a bone of contention between the parties since the Republicans, who lead the House, do not want to increase the size of the government debt, while the Democrats, who control the Senate, with support from the President, do not see any way around it — at least in the near future. While about 30 Republicans declined to vote for a government funding bill if it stipulates cash for Obamacare, Speaker John Boehner and his allies are planning to accede the battle over government funding, which might lead to a government shutdown, to concentrate on the debt ceiling crisis. The President has asserted that he will not negotiate on the debt ceiling, but Senate and House Republicans are determined to strategically exploit the government’s urgent need to lift the debt ceiling to gain politically, especially by targeting the funds for Obamacare. With both sides refusing to compromise, it seems like this will be a replay of the debt-ceiling crisis of two years ago when Congress disputed endlessly and finally evaded default at the last minute. Even though the country dodged defaulting, the ceaseless heated debates in Congress debates had made investors nervous, and the fallout led to volatility and turmoil in the markets. The largest of the credit ratings agencies, S&P, cut the US’s AAA ratings.

In other news, inflation from CPI came in lower than consensus estimates. Our analysts have been predicting inflation at much lower rates than the street and it is the 4th week in a row that actual inflation data (PPI or CPI) came in below street estimates. CPI growth numbers came in yesterday at 0.1% below the expected 0.2%.

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