The countdown continues.  Today US Treasury Secretary Janet Yellen set a date of 5 June as the final date to raise the US debt ceiling. Failure to raise the limit by then will mean the US government would begin to default on its obligations.

What is the US debt ceiling?

The debt ceiling is the legal limit on money the US federal government can borrow to pay its existing bills, such as paying the civil service and military, as well as interest on debt (aka government bonds).  The current ceiling is approximately $31.4 trillion, or $31,400,000,000,000.  It’s been raised 78 times in the last 63 years.

In general, raising it has been a formality.  This time, Republicans are pressing for spending cuts at worth several times their proposed increase in the debt ceiling, which Democrats are resisting.  As the deadline gets closer, the risk is rising that the negotiations will run out of time.

What happens if the US debt ceiling is not raised?

Nobody quite knows the full consequences.

It is true that deadlock in Washington has led to relatively brief government shutdowns three times in the last decade.

But a US debt default has never happened. A total breakdown in negotiations would have many unforeseen consequences, possibly including the public services coming to a standstill, and major moves in the financial markets such as US bond prices plummeting, and significant repricing of equities. The value of the US dollar would also fall, and a US recession would be in prospect.

Is a crisis likely?

As of now, negotiators appear within reach of a deal. “Things are looking good,” Biden told reporters on 26 May. “I’m optimistic.”

But there’s not much time.  Monday is Memorial Day in the US, and it’s estimated any agreement could take a week to be passed by Congress, so the drama will be with us for a week and more.

What should investors do?

The prospect of the US debt ceiling not being raised is a high-impact, relatively low-risk scenario that is very difficult for markets to price in.

The portfolios most at risk are those holding very short-term US debt and high-risk bonds.  The interest rate on US bonds which are due to be repaid over the next few weeks has already jumped significantly.  Safe haven assets like gold and the Swiss franc would become sought-after in the event of a US debt ceiling crisis.

In general however, it is unwise to make knee-jerk adjustments at this point. There’s a reasonable chance of heightened short-term volatility – both positive and negative moves. That might mean it is prudent to avoid placing major trades over the coming days.

The best protection is to have your money invested in a highly diversified, professionally managed portfolio of investments. After that, it’s mainly your fund manager’s and your advisor’s job to mitigate risks such as these.

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