Credit: US Debt Ceiling and Credit Implications

Stay with quality credit
Chief Investment Office20 Jan 2023
  • Investors need not be unduly perturbed by US debt ceiling impasse
  • Holding the world's reserve currency allows the US to finance its debt by printing any shortfall
  • Investors may wish to complement "risk-free" govt debt with low-risk IG corporates
  • Fiscal prudence could ease US inflation and lower the interest rate trajectory
  • These would be tailwinds for high quality bonds
Photo credit: iStock

Here we go again. The issue of the ever-expanding US debt situation has once again come to the fore with the current cap of USD31.4t proving insufficient for the nation’s spending needs. While this debt ceiling has at times been raised or suspended without much fanfare, it becomes trickier under a divided Congress; in this instance the House Republicans are leveraging on this impasse to extract major spending cuts from the Democrats in the name of fiscal prudence.

Been there done that. At this point, investors should no longer be unduly perturbed by the sabre-rattling of politicians. Yes, should the government not be able to borrow more funds, there would be several businesses and households that would be unable to pay their bills while awaiting government receivables. Budgets of local governments could be strained. Large spending drops could see an economy accelerate towards recession and high unemployment, roiling financial markets in its wake.

However, the truth is that ever since the debt ceiling was enacted in 1917, subsequent “crises” of a debt ceiling imbroglio have come and gone – specifically, 78 times since 1960 – with the same results of (a) the limit being suspended or raised, while (b) the US government becoming ever more indebted when the new limits are breached again. We have alluded to this dynamic of an ever-diminishing debt sustainability issue by illustrating that after accounting for mandatory spending items like defense and social security, the US collects only just enough in tax receipts to service interest on its debt. As such, principal repayments will continue to be a recurring problem in the future.

Risk free rate is risky. In 2011, the US got so close to default that its credit rating got downgraded by the credit rating agency S&P, citing risk of default caused by “political brinkmanship”. Ironically, US treasury bonds rallied in its aftermath as investors flocked to “safety” as a Pavlovian response, perhaps not recognising that this safe haven was increasingly exhibiting more cracks.

Such is the exorbitant privilege of holding the world’s reserve currency – the US would always be able to print the difference should there be a shortfall of lenders to finance their ever-growing debt. For now, there is some comfort that they still hold c.USD330b in their Treasury General Account (TGA); funds that they can tap on while Congress negotiates new limits. One can think of the TGA as excess funds in a current account that one can utilise when their credit card and other borrowing limits have been maxed out, and the US does still have some funds saved for rainy days such as these.

US TGA still contains excess funds for a rainy day

Source: Bloomberg, DBS

Stay with quality credit. Given these developments, investors may wish to include exposure to low risk, investment grade credit issuers to complement their holdings in “risk-free” government debt as part of an overall fixed income portfolio. Investment Grade corporates are, after all, rated well because of strong balance sheets and interest serviceability, the same of which we cannot say of certain sovereign issuers.

Additionally, a shift in congressional discussions towards more fiscal prudence could be positive in the US’s fight against inflation, taking pressure off the Fed and its monetary policy from being the only tool to slow an overheating economy. Should rates continue a lower trajectory, this would present a further tailwind for high-quality bonds down the road.

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