A new risk factor for markets:
Equity markets have been hitting all time highs lately but the imminent debt ceiling is an event that could pose a threat to the market in the near term.
U.S. stocks keep shaking off any potential bad news to keep driving higher on the back of positive news and developments. The Fed is unlikely to raise interest rates for another couple years, although they’ll likely taper bond purchases earlier than that. Most of the market is pricing in the fact that inflation will return to normal within the next 12 months or so. There is also the fact that a large majority of market watchers and analysts are expecting gains in the stock market to continue. Despite all of this, Treasury yields keep going lower since they peaked back in march and it indicates there is some degree of worry among investors who are seeking out safe havens.
31st of July is the date that the U.S. government will hit the debt ceiling. In theory, that would be the date that the U.S. government could no longer borrow new money for operations. Without the ability to raise new capital, the government could miss or reduce interest payments on existing outstanding debt, resulting in a credit default that would irreparably damage the reputation of U.S. sovereign debt. Historically, Congress has always elected to simply lift the debt ceiling, but there are indications that there could be a fight leading up to the July deadline this year. As most of us know, the U.S. political environment has become highly partisan. Following an unprecedented increase in the federal debt over the past few years, which has included corporate tax cuts, numerous stimulus and consumer relief packages related to the COVID pandemic and a potentially new infrastructure package on the way, a new battle could emerge over limiting new debt issuance, cutting spending or both.
Although the risk of a debt rating downgrade or an outright default are very low, the last time stocks rose and bonds reversed course was in 2011 prior to another debt ceiling deadline and markets fell around 17%. Treasuries indicate that investors are getting defensive again. It could be the upcoming debt ceiling limit, rising debt levels in general, concerns over a slowing recovery or even the delta variant. Whatever the reason, the caution signals are presenting themselves. It wouldn’t be a surprise to see a spike in volatility this summer that could pull risk asset prices down.