Read time: 5 minutes
Avoiding the effects of a default
Coming this close to missing the deadline to raise the debt ceiling before the U.S. Treasury could no longer finance government operations is certainly not good news. Nevertheless, markets and investors can breathe a sigh of relief if a deal gets across the finish line.
The most serious impact of failing to ratify the deal would be a default by the U.S. government. This would happen if the U.S. Treasury delayed interest or principal payments on Treasury securities. A “technical default” would occur if the Treasury failed to make payments when due on its noninterest obligations, such as to government contractors or to recipients of entitlements such as Social Security.
A default would damage U.S. credibility. The United States would no longer be able to fully reap the benefits—notably, financing on the best possible terms—bestowed on the most reliable debtors. The government’s own financing costs, borne by taxpayers, would increase. And since broader borrowing costs are pegged to Treasuries, interest rates would also likely rise for businesses, homeowners, and consumers.
Failure to approve a deal and raise the debt ceiling would also pressure stocks because higher rates would make companies’ future cash flows less predictable. Spillover effects for global markets and economies would be likely. Such developments, occurring at a time when global recessionary risks are already increasing, make averting such a scenario even more crucial.
How investors should respond to the news
Headlines about the debt ceiling and other short-term events can be unsettling for markets, the economy, and investors. But it’s important to remember that volatility moves in both directions—up as well as down—and that markets are efficient at processing news. Markets don’t like uncertainty, but they are also forward-looking.
A long-term perspective for investors is critical in any market environment but especially in unsettled ones. Market-timing is incredibly challenging because the best and worst performance days often happen close to each other. In many cases, timing the market for reentry simply results in selling low and buying high.
Throughout the debt ceiling negotiations, we have reassured investors and counseled them to focus on the things they can control, such as:
- Having clear, appropriate goals.
- Having an appropriate mix of assets to achieve those goals.
- Keeping investing costs low.
- Maintaining discipline in a well-considered investment plan.
And our advice to investors has not changed because of the deal that is about to go before Congress for approval. A long-term agreement to raise the debt ceiling is welcome news for the economy and markets. Failure to resolve the impasse could cause much more uncertainty, market volatility, and damage to U.S. credibility. But the debate should have little impact on your well-structured investment plan, which should maintain a long-term perspective and ignore short-term events.
- All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
- Investments in bonds are subject to interest rate, credit, and inflation risk.
- While U.S. Treasury or government agency securities provide substantial protection against credit risk, they do not protect investors against price changes due to changing interest rates. Unlike stocks and bonds, U.S. Treasury bills are guaranteed as to the timely payment of principal and interest.