Here’s what the debt ceiling crisis means for your portfolio
Many investors are preparing for the financial fallout of the deadline for the US to raise the debt ceiling or default on its obligations. They are worried about what the debt ceiling crisis means.
Treasury Secretary Janet Yellen said on Sunday that failure to raise the debt ceiling will cause a “steep economic decline” in the US, reiterating the country’s early June deadline.
Experts say the current crisis may be different from the 2011 debt standoff, which ultimately led to a US credit downgrade and significant market turmoil.
“Congress was willing to play the chicken game, but there were fewer members of Congress who were actually willing to crash the car,” said Betsey Stevenson, a professor of public policy and economics at the University of Michigan.
One of the major concerns is how the Ministry of Finance can prioritize principal and interest payments for assets such as bills or bonds at an unprecedented standard.
Under the 2011 contingency plan, there would not have been a default on Treasurys, according to a transcript of the August 2011 Federal Open Market Committee conference call.
While some experts point to the 2011 plan for clues about how the Treasury might prioritize payments now, Stevenson said it is unclear what might happen more than a decade later under different leadership.
Pay attention and prepare to be a bit more defensive.
Steve Sosnick, chief strategist at Interactive Brokers, noted that although some short-term Treasury bills, such as 1-month Treasury bills, have a modest hesitation priced into yields, longer-term Treasury yields show expectations that any debt problems will be resolved quickly.
On May 8, 1-month Treasury bills paid 5.411%, which is above the 5%-5.25% federal funds rate, while 2-month Treasury bills offered 5.134%.
Moreover, the Cboe Volatility Index, which measures expected market volatility over the next 30 days, does not show that the markets are particularly worried yet. “We’ve seen this movie before,” said Sosnick. “And it always reaches right up to the cliff, but we never go over it.”
“I think most market participants will wait until this becomes even more imminent,” and as the deadline approaches, things could change, he said.
In the meantime, don’t do anything rash, Sosnick suggested. But it’s a good idea to set up your antenna and think about how you can secure or become “a little more defensive” if necessary.
For example, if you invest with leverage, which means borrowing money to buy more assets, you may want to pay it back,” Sosnick said. “Stick with companies that are a little more solid with definable profit streams and cash flows.”
The next few weeks will be huge for news and signals for stock markets.
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