The Debt Ceiling, Politics and the Unknowns

Daniel Hawley |


"All we can do I think collectively is to pray that everyone in the United States understands how important the sanctity of the sovereign signature of the leading currency, of the leading bond market, of the leading economy in the world is" Phillip Hildebrand, Vice Chairman of Blackrock

The US has never defaulted on its debt, ever! Doing so would cause irreparable harm to the United States and the world as it is the rock on which the global financial system depends. That fact of course has never stopped a political party from playing Russian roulette and using this to their advantage. While the GOP-led house did pass a bill today to hike the debt limit and slash spending this is going to be DOA (dead on arrival) at the senate.

What is important to note here are the "stakes" which are as high as they could be. The economic weight, history and reputation of the United States is on the line. One cannot rule out what the political elite in Washington will cook up, but the word "crisis" comes to mind. From a purely self-preservation standpoint, we would expect politicians to make the right choice here in the interests of themselves and yes, the entirety of the USA. However, what is straightforward is rarely so. In 2011, a debt ceiling standoff led to Moody's downgrading US debt from the highest AAA rating to AA+. A new standoff on the heels of some major bank failures would send a highly destabilizing message to the rest of the world about the economic status of America.

Ordinarily, the Federal Government has until June to raise the national borrowing limit. However lower than expected tax receipts by the Treasury are adding an extra wrinkle into the equation. It is possible that the U.S. government will - as a result - be unable to pay interest and principal to the country’s lenders before June/July. This is a risk that Wall Street is increasingly considering as a possibility.

On the positive side of the economic equation, inflation is turning the corner down one hundred basis points in March and 410 basis points since the June 2022 highs. Housing or real-time rent data, which has been stubbornly high, suggest these too will fall over the coming 3-8 months. It is unlikely that the Federal Reserve will cut rates until the trend is firmly in, but they may at such point the data is compelling enough across all sectors, decide to pause.

Blackrock's Hildebrand does not see the soft-landing scenario as a reality this year "The soft-landing idea that's been so embedded in people's minds...I don’t see that happening". However, if the inflation data is compelling enough and Washington does not tank the US economy in the near term by defaulting on the national debt, then it is possible the Federal Reserve may change the narrative with a "pause" and wait and see narrative.

For now, until both hurdles are cleared, the outlook remains uncertain. The debt ceiling is front and center stage. As both these recede, bluer skies may arrive.