Debt Ceiling Drama: We’re in for a Nail-Biter

Debt Ceiling Drama: We’re in for a Nail-Biter

By Brian Horrigan, PhD, CFA, Chief Economist

The issue of the debt limit, also called the debt ceiling, has moved to center stage. On 1 May, Treasury Secretary Janet Yellen warned that the X-date, the date when the Treasury would not be able to meet all of its debt obligations if the debt ceiling is not raised, could arrive in the first half of June, perhaps as early as 1 June. It is terrible timing, coming on the heels of 14 months of aggressive Fed tightening, a shaky banking industry, a slowing U.S. economy, and a world still contending with the Russia-Ukraine war.

Markets will likely get increasingly unsettled as the X-date approaches without resolution. Congress has about four weeks to hatch a deal. Below, I look at five possible scenarios and relate important considerations for each.

Scenario 1: Congress reaches a deal before the X-date

My baseline view is that Congress will pass a deal at the last minute, perhaps literally so. In politics, each party wants to negotiate a deal on its own terms. They also want to avoid a potential crisis.

Downgrade Odds: Low. I believe a downgrade of US Treasurys would be unlikely in this scenario. However, if the deal does not restrain fiscal spending, rating agencies may choose to downgrade Treasurys to send a message about the trajectory of the public debt. Some may recall that Standard & Poor’s downgraded the federal government in August 2011 despite the fact that Congress passed a deal to raise the debt ceiling and so avoided default.