US debt precipice unlikely to derail rally

While all eyes are set on when the US will begin tapering back its quantitative easing programme, the country is also set to hit its debt ceiling in less than two months.

The US will breach its debt ceiling by October unless measures are taken by Congress to avert the situation. After being raised in January this year, the nation’s borrowing limit is presently set to a maximum of $16.7trn (£10.7trn).

US Treasury secretary Jack Lew warned  in a letter to law makers that the extraordinary measures implemented at the start of the year would be exhausted by mid-October, at which point the “Treasury would be left to fund the government with only the cash we have on hand at any given day”.

The government, which makes some 80m payments a month, including social security cheques and military salaries, would have a cash balance of approximately £50m, which would be “insufficient to to cover net expenditures for an extended period of time”.

As such US political leaders have just weeks to reach an agreement on the budget and avoid the debt ceiling being broken.

JP Morgan Asset Management global market strategist David Lebovitz says: “The debt ceiling will be part of these negotiations, and although Washington has been plagued by partisan politics as of late, it seems likely that the Democrats and Republicans will reach an agreement that leaves sequestration in place and does not result in the implementation of new deficit reduction measures.”

Charles Stanley Direct head of research investment Ben Yearsley predicts that there will be some grandstanding between the Democrats and the Republicans but ultimately they will reach a deal as they have to. 

Hargreaves Lansdown senior investment manager Adrian Lowcock concurs: “The US’s debt situation is becoming a regular occurrence and while there may be some market volatility I expect that politicians will comfortably negotiate their way through this. As they will certainly not want to restrain economic progress.”

Yearsley adds: “While the debt level is huge, it is worth bearing in mind that the economy has been growing and therefore the debt to GDP ratio will improve. In 2008, the debt level was far higher than it is now and by 2015 it is expected to contract to 2 per cent.”

But Lebovitz explains that investors must bear in mind that neither party wants to be blamed for a debt-ceiling induced default, which is why he believes a compromise is the most likely scenario.

“Although this situation could cause short-term market volatility, it seems unlikely to have a longer-lasting impact on the market,” he says.