A deal on the debt ceiling

After the agreement reached the previous weekend, the US Congress passed in early June 2023 the law suspending the debt ceiling, signed by the president on 3 June. That closed an episode of several weeks of tension over the country’s ability to meet its payments.

The outcome was received with relief by markets, which had followed the negotiations for weeks with some unease. Even so, it is worth looking at the episode in perspective: a crisis avoided at the last moment is not the same as a problem solved, and it leaves useful lessons for anyone managing wealth or a company. For European markets, the agreement was a relief for two reasons: it removed a source of volatility and reduced the likelihood that turbulence in the United States would spread to financing in euros.

How it was resolved

After weeks of negotiation, an agreement reached the previous weekend allowed Congress to pass in early June the law suspending the debt ceiling. The president signed it on 3 June, clearing the risk of default that had worried markets.

Suspending the ceiling means that the legal borrowing limit stops applying for a period, so the Treasury can keep borrowing to pay what has already been committed. It is a common solution in this kind of situation, which buys time without getting into the substance of the matter. The Treasury needs to issue new debt regularly to refinance maturities and cover the deficit, so suspending the ceiling clears that path and avoids delays in payments to suppliers, public employees or bondholders.

Suspending is not resolving

The risk faded, but US public debt kept growing. Suspending the ceiling allows obligations to go on being paid, but it does not address the volume of debt or the deficit behind it. In other words, the immediate emergency is resolved, not the underlying cause.

The outcome was what many had expected, but that did not alter the fact that the procedure had been repeated with unnecessary tension. Each time the limit is reached without a prior agreement, confidence in the country’s fiscal management is eroded a little, and investors take note, even if everything ends well. The persistence of high deficits is a structural issue that is not solved by a one-off agreement. Until it is addressed, the debate will return every time a limit approaches, with its corresponding load of uncertainty.

What came next

That same summer would have consequences for its credit rating. Rating agencies assess not only the capacity to pay, but the strength of institutions and fiscal management. A tense and repeated political process is part of what they observe when evaluating an issuer.

For investors, the episode is a reminder that even debt considered of the highest quality is subject to political risks. It does not mean it should be avoided, but that no asset is free of uncertainty, and that diversification across issuers, maturities and currencies remains a prudent way of not depending on a single outcome. It is worth discussing with the adviser. Rating agencies carry out their assessments using their own criteria and on timetables that do not coincide with those of politics, so a decision like the one that came that summer can occur even though the specific dispute has already been settled. For the prudent investor, the conclusion is not to confuse a favourable outcome with the disappearance of risk, and to keep a portfolio structure that does not depend on every political episode turning out well at the last moment.

A crisis avoided in time makes fewer headlines, but it is worth remembering how close it came.

This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.