Explaining the impact of rising the U.S. debt ceiling

The approval of the debt ceiling increase in the U.S. has been capturing headlines over the past few weeks, and as I write this (on Friday June 2) we just heard that the vote has gone through the U.S. Senate and President Joe Biden will sign the increase into law later tonight or tomorrow morning.

So, by the time you read this column on Monday, this should all be behind us (yet again). While this may have been front page news recently, it’s important to understand this is the 78th time the ceiling has been “raised” since 1962.

In the simplest terms, raising the debt ceiling provides the U.S. federal government with the ability to borrow more money to meet its financial obligations. When the debt ceiling is reached, the government cannot borrow any more money unless it is increased by an act of Congress. Failure to raise the debt ceiling can lead to severe consequences, including defaulting on debt payments, which could trigger and economic crisis.

But what does all of this mean for you?

This decision can potentially hold far-reaching implications for both average consumers and investors, as it affects various aspects of the economy. In this week’s column, I will explore what the approval of the debt ceiling raise means for the average consumer and investor:

The impact on average consumers includes:

Interest rates—The approval of the debt ceiling increase may lead to rising interest rates. When the government borrows more money, it increases the demand for credit, which can push interest rates higher. Consequently, consumers may experience increased borrowing costs for mortgages, auto loans, and credit cards, impacting their ability to make major purchases and manage their debts effectively.

Inflation—The decision to raise the debt ceiling can have implications for inflation. The government's increased borrowing puts additional pressure on the money supply, potentially leading to an increase in prices. As prices rise, the purchasing power of consumers decreases, making goods and services more expensive. Consumers may find their budgets (even further) stretched as they face higher costs for everyday necessities.

Consumer confidence—Uncertainty surrounding the debt ceiling can dampen consumer confidence. If consumers fear that the government's financial stability is at risk, they may become hesitant to spend, save, or invest. This reduced consumer confidence can have a negative impact on the overall economy, affecting businesses and job growth.

The impact on investors includes:

Stock Market Volatility—The approval of the debt ceiling rising can result in increased volatility in the stock market. Investors dislike uncertainty, and the debt ceiling debate can create anxiety and lead to fluctuations in stock prices. Investors may need to re-evaluate their investment strategies to navigate the potential market turbulence.

Bond Market Performance—The bond market, particularly U.S. Treasury bonds, can be directly affected by the debt ceiling. If the debt ceiling is not raised promptly, it could increase the risk of default on government debt. This risk may cause bond prices to decline and yields to rise, affecting fixed-income investors who rely on bonds for stable returns.

International investor confidence—The debt ceiling debate can impact the perception of the United States' creditworthiness among international investors. Failure to raise the debt ceiling in a timely manner could undermine confidence in the U.S. economy and its ability to meet its obligations. This could result in a decrease in foreign investment and a weakening of the U.S. dollar's value against other currencies.

The approval of the debt ceiling increase may seem like an averted crisis and the stock market returns on Friday would point to exactly that. But it’s important to be aware of the lingering issues that brought us to this point and the potential impacts this raise can have on things like inflation and interest rates.

As always, the best defense for market and economic turmoil is a well laid out and regularly updated financial plan with a well-diversified portfolio.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.