The 2023 debt ceiling crisis disrupted some markets but left limited economic impact

The near shutdown of the US government in September and the debt ceiling crisis in the first half of 2023 have forced Americans to become more accustomed to government dysfunction. The uncertainty resulting from such crises temporarily increases government borrowing costs even if default does not occur. But other key indicators of financial health including VIX, a measure of volatility in the market, have not been discernibly affected in recent debt ceiling scares, with the exception of 2011, when disruption was more widespread.

Shortly after the default confrontation in June, which was defused two days before the so-called X date (the date on which the United States would be forced to default) by a bipartisan congressional vote to expand the debt limit, Fitch Ratings downgraded debt backed by the United States Treasury from AAA to AA+. That move of August 1, 2023, removed the United States from the club of top-rated countries including Australia, Germany, and Denmark, relegating it to a slightly less prestigious group including Canada, Finland, and New Zealand. Fitch cited "the erosion of governance…manifested in repeated debt ceiling standoffs and last-minute resolutions" as the reason.

The looming possibility of a debt ceiling breach earlier in 2023 caused government borrowing costs to rise, particularly in Treasury securities scheduled to mature around the so-called X date. Similarly, spreads on credit default swaps, which have reacted to past debt ceiling crises, moved in June. However, other key measures, such as the S&P 500 and VIX, did not respond. By contrast, in 2011, the effects of debt ceiling brinksmanship were not limited. Disorder in the financial markets reflected a widespread consensus that an actual default on US debt—as opposed to the disruptions and inconveniences caused by a government shutdown—would have far-reaching repercussions for markets, interest rates on US debt, and the economy at large.

The only other time that the United States' credit was downgraded was by S&P on August 5, 2011. Comparisons between 2023 and 2011 are natural. In both cases a Republican-controlled House of Representatives initially refused to deal with a Democratic president to raise the debt ceiling for months prior to the X date; a deal was reached only two days prior.

What do financial markets signal around the dates of debt ceiling legislation?

 Beyond short-term disruptions, one place to look for wider impacts would be in the long-term bond market. Accordingly, the figures below provide an event study of various metrics, including the long-term bond yield, covering a span from 21 business days before to 21 business days after the passage of debt ceiling legislation, showing the mean and 5th and 95th percentile lines.[1] The events for 2011 and 2023 are also graphed individually, to show how they compare to average debt ceiling events. For long-term yields, all lines are essentially horizontal: Debt ceiling legislation has little effect.

Other financial markets look similar. The slope of the yield curve, defined as the difference in yields between the 10-year note and 3-month bill is a common metric of the state of the business cycle. It also is horizontal and does not respond to debt ceiling events.

The S&P 500, however, suffered its largest drop in August 2011 since the global financial crisis, falling by almost 7 percent in the first trading day after the credit downgrade, and more than 16 percent in just over 5 weeks in July and early August. It took more than six months for the market to reverse these losses. In 2023, on the other hand, there was remarkably little change in the S&P 500 during the debt ceiling debates, indicating that participants in these markets did not anticipate a significant risk of default.

The volatility index (VIX) rises markedly at the 95th percentile around debt ceiling events and rose during the 2011 debt crisis. However, the average debt ceiling event does not impact the VIX. In this metric, 2023 more closely resembles an average event than 2011.

Conclusion

 Recently, there has been a rise in US Treasury borrowing costs, driven by many factors, especially concerns in the markets about the US government's long-term fiscal health and debt sustainability. A general perception of government dysfunction in addressing these issues has deepened those market concerns, and periodic debt ceiling crises are a symptom of that dysfunction. But the data points presented here indicate that despite a significant risk premium for government borrowing in short-term markets, the debt ceiling crisis of 2023 left essentially no imprint on other indicators of financial health.

Note

1. Because some debt ceiling suspensions were relatively short and analysis is done over a 43-day window, some overlapping events are analyzed.