US Debt Ceiling Crisis: Can It Affect Traders?

May 11, 2023 14:58

The US debt ceiling crisis draws more and more attention every day that passes as the US government should make sure it can repay its debts to lenders. As the US economy is one of the largest in the world, negotiations over the debt ceiling tend to compete with inflation talk when it comes to financial news headlines.

This is not the first time that this has happened. Over the past few years, some US governments found themselves cornered trying to raise the debt ceiling in order to repay debt. Last-minute compromises and deals saved the day on most occasions. However, such negotiations may create a feeling of uncertainty in financial markets.

Should traders be on alert as the US dollar and its value against competitors could be in the eye of the tornado? Will stock markets face the perfect storm? Read our blog as we explain the debt ceiling and how it could affect markets in the next few weeks.

What is the US debt ceiling?

Governments need to borrow money to be able to pay their debts. There are several ways that this can be done, such as issuing government bonds etc. Governments use these funds to pay salaries, finance their investment plans and other such obligations.

The US debt ceiling is a legislative limit on the amount of national debt that can be incurred by the U.S. Treasury. Therefore, the debt ceiling puts a limit on how much money the US federal government can borrow to cover its financial needs. Analysts note that if the debt ceiling is reached without any prospect for an increase, the government would have to use “extraordinary measures” to finance expenses until the issue has been resolved. 

As negotiations regarding the US debt ceiling aren't something new, the country’s Treasury has never been forced to use “extraordinary measures.” The 14th amendment of the US Constitution notes: “the validity of the public debt of the United States...shall not be questioned.,” with some analysts suggesting that the US government could be unable to default on its debt, even if spending exceeds the limit set by the debt ceiling.

US debt ceiling negotiations: The clock is ticking

The US debt ceiling is currently $31.4 trillion. The US government wants to raise it but negotiations between Democrats and Republicans haven’t delivered any positive results. A report by Moody’s Analytics forecasts that “in a prolonged stand-off, stock prices would fall by almost a fifth and the economy would contract more than 4%, leading to the loss of more than seven million jobs.”

A report by CNN, published on May 9th, suggested that the US Treasury Secretary Janet Yellen has been calling business leaders across the country to inform them about the impasse. Yellen has urged Congress members that the US could default on its obligations as soon as June 1st if lawmakers don’t address the debt limit before then.

Speaking at the G7 finance minister meeting, the US Treasury Secretary Janet Yellen stressed: “The notion of defaulting on our debt is something that would so badly undermine the U.S. and global economy that I think it should be regarded by everyone as unthinkable. America should never default.”

What do market analysts think about the US debt ceiling negotiations?

Moody’s Analytics experts noted in their report that “what once seemed unimaginable now seems a real threat. If there is a breach, it is much more likely to be a short one than a prolonged one. But even a lengthy standoff no longer has zero probability.” In an additional comment regarding a potential ceiling breach, they suggest that there is a 10% probability.

US Chamber of Commerce officials told Reuters reporters that negotiations between the two sides regarding the debt ceiling are positive steps towards a solution but mentioned that “we cannot stress enough that time is short, with each passing day increasing the risk for a misstep resulting in a default.”

The Bipartisan Policy Centre (BPC), a think tank monitoring debt limit disputes based in Washington, wrote in a report (May 9) that the U.S. government could begin defaulting on its payment obligations between early June and early August without an increase in the federal debt limit.

Commenting on the negotiations, the BPC’s director of economic policy noted that “the coming weeks are critical for assessing the strength of government cash flows. If a solution is not reached before June, policymakers may be playing daily Russian Roulette with the full faith and credit of the United States, risking financial disaster for their constituents and the country."

ING economists suggested that lengthy negotiations over the debt ceiling lend support to the US dollar. “The current situation is inevitably weighing on risk sentiment and offering support to the Dollar. There is now growing concern that it might actually take a market sell-off (in the equity or money markets) to break the impasse. This would be a scenario where the Dollar would get a significant near-term boost, also considering USD speculative shorts have risen steadily in the past few months, and one of the reasons why we favour a delay in the start of the greenback’s downtrend to the third quarter.

A Brookings Institution report quoted in a White House survey said: “Worsening expectations regarding a possible default would make significant disruptions in financial markets increasingly probable. Such financial market disruptions would very likely be coupled with declines in the price of equities, a loss of consumer and business confidence, and a contraction in access to private credit markets.”

US debt ceiling talks, the US dollar and risk management

The US dollar is the most traded currency worldwide. Developments concerning the US economy are likely to have an effect on the US dollar’s value against other currencies such as the British Pound, the euro and others. Rate fluctuations could take a toll on your trading strategies, especially if they are unexpected. Trading, when markets move against you, can result in a loss of funds; in the case of a beginner trader, the chances of failure could be increased due to lack of experience.

Risk management is essential as beginner traders are not experienced in facing adverse market conditions. There is a large range of risk management tools that beginner traders can utilise when building a trading strategy. Although brokers offer these tools, knowing how to use them is important. You might be wondering how you can learn. Educating yourself is the answer. Reputed brokers offer a wide array of educational materials such as webinars, e-books, articles prepared by trading professionals giving you the answers you are looking for. Beginner traders should never neglect the value of risk management which allows them to enjoy the thrill of trading with less stress and anxiety.  

Does trading on macroeconomic news interest you? Learn how this approach works with our free webinars. Meet and interact with expert traders. Watch and learn from live trading sessions.

Free trading webinars

Tune into live webinars hosted by our experienced traders

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

Miltos Skemperis
Miltos Skemperis Financial Content Writer

Miltos Skemperis’ background is in journalism and business management. He has worked as a reporter on various TV news channels and newspapers. Miltos has been working as a financial content writer for the last seven years.