The US Government’s dance with debt has taken an interlude after the US Senate passed bipartisan legislation last week to lift the government’s US$31.4 trillion debt ceiling, avoiding what could have been the first default in the history of the world’s largest economy.

The decision came after weeks of nail biting negotiations between the Democrats and Republicans, and with mere days to spare before the 5th June 2023 deadline, by when the US Treasury Department warned it would be unable to pay down the debt if negotiations failed.

Despite the good intentions behind the suspension, some market experts have noted that the hastily drafted debt ceiling deal is not a long-term solution to the US’s total federal debt buildup which is on track to exceed US$50 trillion in a decade.

In the near-term, the ripples of the suspension are being felt by the market in more ways than one. Among the first to be impacted were US banks, whose shares fell on Monday over concerns that Treasury bill issuance following the suspension would drain lenders of liquidity. 

Investors are reported to be ‘bracing for a wave’ of Government bond issuance as the Treasury seeks to restore its depleting vaults to their former glory. A Deutsche Bank strategist expects an estimated US$1.3 trillion in net bill issuance by the end of the year, with US$400 billion expected in June alone.

Also with its undeniable presence, higher interest rates are expected to weigh into the country’s debt service costs which are projected to triple to US$1.4 trillion by 2033.

On the other hand, Reuters have reported that some of the world’s leading investment banks  noticed hedge funds flocking to US stocks and away from their European counterparts. On the Friday after the debt ceiling suspension, the US S&P 500 surged to its highest in almost a year.

One of the banks observed that net buying in North American stocks by hedge funds reached its highest level in five months with information technology (IT), consumer staples and health care leading the charge. Net-selling in US energy stocks reached 10-week highs, close to its highest levels since 2018.

Another drew up a similar report card, swapping out IT for financial companies and stating that markets are experiencing ‘hotter but shorter’ earnings cycles, also noting that an earnings recession, though likely this year, is yet to be priced by markets. 

As a potential bonus to the country’s economy, US crude oil exports are expected to rise next month on the back of a record high level of 4.5 million barrels per day (bpd) in March, after Saudi Arabia declared on Sunday its intention to drop production by 10% to 9 million bpd in July. Notably, US crude oil reserves are near their historic lows.

Despite the level of drama surrounding this year’s debt ceiling, the US has found itself in even dire situations in the past. In 2011, a similar political standoff led to turmoil among financial markets, the country’s first downgrade of the government’s credit rating and an increase in the nation’s borrowing costs.

In 1995, the infamous shutdown of the Bill Clinton-led US Government was a direct consequence of the Republican party threatening to disallow an increase in the debt ceiling to negotiate cuts in government spending and the then President’s refusal to make the cuts.

Past performance is not a reliable indicator of future performance.

Source: Thomson Reuters, 5th June 2023