Facing the U.S. Debt Ceiling, Again

Viewpoints and Frequently Asked Questions

Fiscal issues in the United States are once again having a far-reaching impact in global markets. After profound disagreements over a temporary U.S. budget caused a partial government shutdown in early October, an ugly battle has loomed over raising the statutory debt limit. The country faces a technical default if no deal is reached before the U.S. Treasury exhausts its borrowing capacity.

Jeff Rosenberg
BlackRock Chief Investment Strategist for Fixed Income

"Brinksmanship appears again to be the negotiating stance but as before, when it comes to the much more damaging outcomes of a failure to raise the debt ceiling, there likely will be another kick-the-can last-minute compromise."

"Debt ceiling concerns likely generate headlines but we would be cautious on abandoning risk positions over these short-term events."

Russ Koesterich
BlackRock Chief Investment Strategist

"As there’s a very good chance that Washington will produce yet another temporary patch to avert a default (for example, a hike in the debt ceiling that only lasts three months), we’re likely to be back in the same position a few months down the road."

"In short, if political uncertainty over the budget and debt ceiling becomes a semi-permanent fixture, market volatility is likely to remain higher than the summer’s placid levels. Under this regime, investors may need to reacquaint themselves with what a more volatile world feels like."

The U.S. Fiscal Picture

The BlackRock Sovereign Risk Index, which ranks countries by fiscal and financial metrics, ironically shows the U.S. score has been improving. While the qualitative and institutional measures of the country’s Willingness to Pay has been sliding, the Fiscal Space component, which gauges whether fiscal dynamics are on a sustainable path, has been improving steadily as projected deficits have shrunk.

FAQs
Here are a few answers to frequently asked questions about the U.S. government shutdown and debt ceiling situation.

What is the cause of the U.S. government shutdown?
The fiscal year ended on September 30^th, at which point a new spending bill would have/should have been passed.  Initially, the shutdown appeared to be the result of Congressional disagreement over the allocation of funding for the Affordable Care Act, often referred to as “ObamaCare.” The Republican majority House passed a spending bill that maintains current spending levels, but does not provide funding for ObamaCare.  By contrast, the Democrat majority in the Senate has stated that they will not consider anything other than a Continuing Resolution (CR) that does not require policy change and provides funds for the implementation of existing law.  More recently, the Republican position appears to be linking the CR to the U.S. federal debt limit negotiations.

There has been significant news coverage of the debt ceiling debate in Washington. What makes this time different from the 2011 situation?
In 2011, politicians used a debt-limit increase to force deeper spending cuts, a political showdown that caused the U.S. to come within days of default and led to a credit-rating downgrade by Standard & Poor’s. Republicans used the potential of default to force spending cuts. The legislation allowed a $2.1 trillion increase in the debt ceiling.  Failure to come to an agreement would have greater economic consequences as a failure to raise the debt ceiling represents a tightening of fiscal policy. In other words, the government slows its rate of spending, slowing the rate of growth in the economy.

What is the likely outcome of the debt ceiling debate in Washington?
Given all of the complexities, it is impossible to specifically predict the outcome. Given the potential to inflict real harm to the economy and the negative and unknown political implications of such a result suggests a rational course of action would avoid this outcome at the last minute. However, a different interpretation of what constitutes political advantage may change that assessment undermining the market consensus view that a last minute compromise - even if devoid of actual economic substance - will eventually be reached.

October 17^th is often cited in the media as a “deadline” to raise the debt ceiling. What actually happens on October 17^th?
October 17th is the date presented by the Treasury Secretary to Congress as the last date at which extraordinary measures can be used to extend the Treasury’s borrowing authority. The U.S. Government will be forced to make difficult decisions in preparation for the debt ceiling being reached. If it is not raised by October 17, 2013, the U.S. Government will begin straining its ability to make future payments on its principal and interest obligations.

There has been a lot of news coverage about rating agencies commenting on the debt ceiling. What has been happening?
Despite the current debt ceiling debates, Fitch Ratings has said that they expect to resolve their negative U.S. outlook by the end of the year and Moody’s Investors Service has affirmed its top rating for the U.S.

The likelihood of a downgrade is linked to the possibility of a U.S. Government technical default on its debt obligations. Should a default and subsequent downgrade occur, the assumption is that the missed payment would result in a temporary “Selected Default” (SD) rating which would be restored once a payment is made.