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What I Care About This Week | 2023 Jan 16

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Photo by Sebastian Arie Voortman on

by Franklin J. Parker, CFA

The Summary

The Details

Well, the debt ceiling is back in the news. Why does it matter to investors?

The debt ceiling is a check on the power of the US Treasury. In a nutshell, congress authorizes spending but gives the US Treasury lots of leeway over how to fund that spending. Obviously, ongoing tax receipts are a major source, but because the government spends more than it receives in revenue the US Treasury must issue debt to cover the shortfall. Congress says that’s okay, but only up to a point. That is the debt ceiling.

Investors view US government debt as among the safest debt in the world. This means that lots of cash is tied up in US government debt — and that is typically cash that cannot afford to be lost. Furthermore, because investors see little to no chance of default in US government debt, it is the benchmark by which all other debts in the economy are priced. That is, if I can lend my money to the United States at 4.5% and get paid back for sure, I will need to earn more than 4.5% on my money to lend it to my uncle Jack since I have much less of a chance of getting paid back.

For the US government to default on her debt obligations, not only do lenders to the government lose money they cannot afford to lose, but the fundamental benchmark of the economy is undermined. Investors would have a strong sense of vertigo while scrambling to find a new benchmark from which to price home mortgages, car notes, credit card rates, and other bond rates.

In short, the US government outright defaulting on her debt is an economic catastrophe. Which is why investors care so much about the chances of that happening.

Chart of the Week

Many financial analysts and news organizations have dedicated an inordinate amount of time to the question of what the Fed’s next move might be. There is good reason for this, as the chart below demonstrates. The S&P 500 has followed the Fed for the past year — as rate expectations have risen (black line, and lower means higher rate expectations), markets have fallen. Even divergences (like March-April of 2022) get reversed pretty violently.

Since October, the market has begun to rally away from the Fed, and partly because expectations have begun to level off. However, poor economic data is beginning to take over, and that may yet push markets lower.

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