What is the US debt ceiling – and does it matter?

What is the debt ceiling? 

The debt ceiling limits the amount of money that the US government can borrow to pay its bills. These bills include salaries for federal employees, military pensions, Medicare, and interest on national debt.  

For many years, the US Congress has voted to raise or suspend the debt ceiling so the government can continue to borrow money. The cap currently stands at $31.4 trillion (£25.2 trillion).  

It was breached in January, and since then, the US Treasury has used ‘extraordinary measures’ so it can keep paying its bills until policymakers can agree on what to do next.  

And the clock is ticking – unless a deal is made, there is a chance that the US government could run out of money as early as 1 June.  

What’s the issue? 

The debt ceiling is reached every few years, and most of the time, agreeing to raise or suspend it is a formality.  

But, as has become the case in recent years, Democrats and Republicans (the two main political parties in the US) disagree about what should happen next.  

Democrats want to raise the ceiling without conditions, but Republicans are digging their heels in and want spending cuts to be part of the deal that allows the ceiling to be lifted.  

If they don’t reach an agreement in time, the United States could theoretically default on its debt. This means that the government would no longer be able to pay salaries or creditors, and parts of the government may shut down.  

The global economy would also be impacted because US government bonds are typically seen as amongst the safest investment assets, with high credit ratings and very little probability of default.  

It’s safe to say that the issue is highly political. But it’s important to remember that this isn’t the first time the future of the ceiling has been contested – or used for partisan purposes.   

What does it mean for investors? 

While this might all sound unsettling, investors would do well to keep a long-term perspective in mind.  

Over the last 100 years, the debt ceiling has been lifted regardless of which party has been in power. A cap on debt has been in place since 1917, and the ceiling has been raised or suspended 102 times since the Second World War – the last instance being in 2021. 

Ultimately, Washington has been through this scenario several times before, and has always found a resolution. The chances of the US government running out of money are therefore very low, but as we near 1 June, the political risks are rising. 

Right now, markets are calm. Investors may see a rise in volatility in the coming weeks as policymakers continue to work on a deal and the deadline approaches. This was the case in 2011, for example, when negotiations came down to the wire.

But since then, when the issue has reappeared, markets seem to have been driven more by the prevailing market and economic issues of the time – reassured perhaps by the strong track record of a resolution and the very low probability of default. After all, no member of Congress wants to be responsible for the first default in US history.  

Here at Nutmeg, we’ll be keeping an eye on the negotiations as part of our day-to-day market monitoring, but we don’t expect to be making any reactive changes to the strategic asset allocation of our portfolios in response to any developments.    

In the meantime, the best thing investors can do is to stay focused on their long-term plan, and continue to invest in a diversified portfolio suited to their risk level.  

You can keep up to date with our news and views via our Nutmegonomics page and YouTube channel – and if you’d like to speak to someone in our friendly team about your portfolio or financial markets, just book a free call today.  

Risk warnings  

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance.