While we don't expect the U.S. government to default, the uncertainty may heighten market volatility in the coming days. Here are answers to some of the questions we're hearing most often.
Investors have been uneasily watching the standoff in Washington over raising the federal "debt ceiling" before the U.S. government runs out of money to pay its obligations. While we at Schwab believe that a government default is unlikely, fears around the issue are likely to affect market performance in the coming days. Here are some of the questions we're hearing from investors about the current situation, the implications of default, and what you can consider doing now.
What is the debt ceiling and why do markets care?
The debt ceiling is the total amount the U.S. government is authorized by Congress to borrow to meet its existing obligations, including interest payments on Treasury securities. It's currently $31.4 trillion. The government hit that limit in January 2023 and has been using accounting maneuvers that get around the debt ceiling (referred to as "extraordinary measures") to pay its bills since then. On May 22nd, Treasury Secretary Janet Yellen told Congress that it was "highly likely" that the Treasury would run out of money to pay its bills "by early June, and potentially as early as June 1," unless Congress raised the debt ceiling.
If the U.S. government should fail to make interest payments on Treasury securities, it would have "defaulted" on its legal debt obligations for the first time in history, and the market reaction likely would be very negative. We also believe that if the Treasury made its debt payments on time but didn't make timely payments on its other financial obligations (e.g., salaries, Social Security payments) the market reaction also would be negative.
Hasn't this happened before?
There has never been a default. The closest parallel to the current standoff is the 2011 debt ceiling crisis when the U.S. government came the closest it has ever come to default before a last-minute agreement was approved by Congress to raise the debt ceiling. It was resolved on August 2, 2011. Although the U.S. did not default, credit rating agency Standard & Poor's took the unprecedented step of downgrading the U.S. government's long-term credit rating from AAA (the highest credit rating) to AA+ on August 5, 2011, and market volatility continued even after there was a resolution.
Why is there uncertainty about the exact date a default would occur?
The flow of receipts and outlays at the Treasury is inherently unpredictable, making it difficult to pinpoint an exact time for default. In a May 22nd letter to Congress, Yellen reiterated that "it is highly likely that Treasury will no longer be able to satisfy all of the government's obligations if Congress has not acted to raise or suspend the debt ceiling by early June, and potentially as early as June 1." June 15th is the date when quarterly tax payments are due. If the U.S. government has not defaulted by then, those tax receipts would help it avoid default for another couple of weeks.