Treasury Secretary Janet Yellen has declared that the US has hit its federal debt limit, kicking off an intense political battle that puts the global financial system at risk.
Congress and the White House have until at least early June to resolve the issue, and in the coming months investors will begin to see the impact of a possible US default on its payment obligations. Here’s what the fight could mean for jobs, stocks, bonds, your tax refund and more.
Q: What is the debt ceiling?
It’s an overall limit — currently set at almost $31.4 trillion — on how much debt the Treasury Department can issue. Raising the ceiling lets the government borrow to cover the gap between spending and taxes already approved by Congress. Yellen announced Thursday that Treasury would deploy accounting measures to avoid missing payments to bondholders. These moves will likely work through early June.
Q: What’s the issue now?
A group of Republicans in the House of Representatives wants to force President Joe Biden to agree to cuts in spending by threatening not to raise the debt limit. The White House argues the debt ceiling shouldn’t be conditioned on any other action. An impasse has ensued.
Q: What does it mean for stocks and your 401(k)?
Most analysts believe the US will avoid a default, so the effects of a political showdown on stock values would be temporary.
“The political squabbles in the coming weeks will likely lead to stock market volatility,” said Shane Sideris, co-founder of Synchronous Wealth Advisors in California. “But, for long-term investors, there is nothing to worry about. The debt ceiling has been raised 45 times in the last 40 years.”
Still, the volatility could be a problem. The current political situation most closely resembles 2011, when President Barack Obama faced off with a Republican House and ended up striking a last-minute deal capping federal spending. S&P Global Ratings cut the sovereign US credit rating for the first time. The S&P 500 Index fell 17% near the end of the debt standoff and ensuing downgrade, and the market didn't recover the losses for almost six months.
If the current fight isn’t resolved before the US misses payments on its obligations — everything from interest due on Treasury securities to government benefits including social security — the market declines could be severe.
Q: What does the debt ceiling fight mean for the real economy? Could it increase the risk of recession?
If the debt ceiling is not raised, the US would be forced to drastically cut government spending. That sudden drop would hit as much as 4% of the annualized total for GDP, according to an estimate by David Wilcox, director of US economic research at Bloomberg Economics.
Even a last-minute solution could boost recession risks. Consumer confidence slumped during the 2011 episode.
Q: What does the debt ceiling fight mean for investors in Treasury securities?
Typically, when things darken in the economy, investors buy Treasuries because they’re considered risk free. That was true in 2011, when Treasuries rose in the weeks after S&P’s downgrade, despite the agency effectively saying the US government was less reliable in making good on its debts.
Still, there’s no guarantee Treasuries would rally this time, especially with inflation running hot and the Federal Reserve raising interest rates, according to, John Velis, a macro strategist at BNY Mellon.
“I'm not comfortable saying because what happened in 2011, we're going to see a repeat of that this time,” he said.
In the worst-case scenario, if the US government failed to make an interest or principal payment, Treasuries would almost certainly trade for less than their face value and investors would lose large amounts of money.
Q: How will it affect mortgages, auto loans and other borrowing costs?
The financial turmoil would likely bleed into the wider credit markets, affecting practically all borrowers.
“If the US government defaults, the credit rating would decrease, not unlike an individual’s credit score, and investors would require higher interest rates to compensate for additional risk,” said Marguerita Cheng, founder of Blue Ocean Global Wealth. “Higher interest rates mean higher borrowing costs for cars, autos and even student loans. The combination of higher borrowing costs with higher inflation can put more strain on households and businesses.”
Corporate and municipal bonds would also “tank much harder” than Treasury securities, which would still be “the least-dirty shirt in the laundry basket,” said William Bernstein, co-founder of Efficient Frontier Advisors.
Q: How will it affect the value of the dollar?
Just as with Treasuries, the dollar typically strengthens when bad things happen. Even if Treasuries tumbled this time, the higher interest rates that would produce could support the currency in the wake of a credit downgrade, said Philip Mock, founder of 1522 Financial in Tulsa, Oklahoma.
The dollar may very well strengthen in the wake of the standoff and even in the face of a default. Longer term, however, the blow to confidence in the US could undermine the currency’s dominant position in the global financial system.
Q: Are Social Security benefit payments and tax refunds at risk?
Government benefits are safe so long as the Treasury can use accounting moves to keep the US paying what it owes. While Social Security payments are covered by a dedicated trust fund, the ability to deliver that money may be at risk in the chaos of breaching the debt ceiling.
Some of the largest financial obligations include Social Security and Medicare benefits, tax refunds and interest on the national debt. And if the debt ceiling is reached, the situation can become more precarious because the government won’t have sufficient resources to meet its obligations, according to Cheng. It’s even possible that Social Security payments would get “interrupted,” Bernstein said.
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