Investors Acting Rationally Ahead of Debt Ceiling Deadline

Talks on solving the debt ceiling crisis gained momentum on Tuesday after President Biden, Speaker Kevin McCarthy and others met to discuss ways to diffuse the standoff ahead of a fast-approaching deadline to get something done. 

“We just finished another good, productive meeting with our congressional leadership about a path forward to make sure that America does not default on its debt,” Biden said. 

Meanwhile, McCarthy—who had been the most pessimistic about getting a deal done—sounded a more upbeat tone after the meeting. An agreement could be reached “by the end of the week,” he said. 

Still, both sides remained far apart with regard to what they would be willing to accept in exchange for an increase in the U.S. debt limit. 

Republicans like McCarthy are asking for steep spending cuts, while Democrats like Biden want to cut spending as little as possible (or not at all).  

Still, both sides agree that not raising the debt ceiling by the date the Treasury runs out of money—which could happen as early as June 1, according to Treasury Secretary Janet Yellen—would be catastrophic for the U.S. economy.  

Markets Yawn  

Though the 2023 debt ceiling crisis has been billed as something that could push the U.S. to the edge of default (and perhaps beyond), unlike the debt ceiling crises in 2011 and 2013, this current iteration of the crisis has been met by a yawn in financial markets. 

The SPDR S&P 500 ETF Trust (SPY) has hardly budged over the past several weeks, and the Cboe Volatility Index (VIX), Wall Street’s fear gauge, has been hovering near recent lows. 

For many investors, the sense is that they’ve seen this movie before, and it always ends the same way—with a last-minute deal. 

Given that precedent, you can’t blame investors for not panicking over this version of what is a manufactured crisis.  

Sure, the two political parties in America have seldom been more divided. The Republican’s slim majority in the House gives more leverage to more extreme members of that party as well. 

But do those factors push the odds of a debt default meaningfully higher—enough so that a default becomes a distinct possibility?  

The markets don’t seem to think so. 

Signs of Stress, Not Panic  

In addition to the stability in the stock market, the Treasury market is showing little signs of stress also. The 10-year Treasury bond yield is currently around 3.55%—lower than many people thought it would be with the federal funds rate above 5%—but it’s been here for a while and it’s arguably low for reasons other than the debt ceiling. 

Meanwhile, there’s been some consternation in the Treasury bill market as risk-averse investors shun bills maturing around the time of the debt ceiling deadline in favor of those that mature a few weeks later. 

The current yield for Treasury bills maturing one month from now is around 5.6% versus 4.9% for bills maturing two months from now. 

I’d argue that that’s a sign of risk aversion, maybe even slight stress, but not panic. 

It’s a similar story in the ETF market. We haven’t seen significant flows into Treasury ETFs or gold ETFs, or anything that would signify investors are growing worried as the debt ceiling deadline approaches. 

In fact, we’ve seen outflows of nearly $3 billion from the iShares Short Treasury Bond ETF (SHV) over the past week.  

That just puts the ETF’s AUM back to where it was in February, so I wouldn’t read too much into that, but it reinforces this idea that investors are hardly positioning themselves for a catastrophic debt default. 

Happy Ending  

The odds are that the 2023 reboot of the debt ceiling crisis has a happy ending, just like previous versions of the movie. 

But some people believe the complacency that stems from having experienced similar situations in the past makes it more likely something goes wrong this time around.  

That’s certainly a risk. No one can say that the probability of a U.S. debt default is zero, but even if it’s not, there’s little investors can reasonably do to hedge themselves against a small percentage chance of a catastrophe.  

Upending a long-term investment strategy over an unlikely short-term event would be foolish and costly.  

Sure, there are small, easy things investors could do—like buying T-bills maturing in two months rather than one month—and it’s why there’s that kink in the Treasury yield curve. 

But trimming your allocation to stocks, loading up on VIX ETFs, or buying puts are much costlier moves that don’t make sense for most investors.  

Contact Sumit Roy at [email protected]