Will the Debt Ceiling Be Déjà Vu All Over Again?

Conclusion: Our analysis shows us that another breach of the debt ceiling is imminent later this year.  In 2011, the SP500 had a drawdown of -16.8% around the debt ceiling debate.


Last summer during the debt ceiling debate, the U.S. equity markets were volatile to say the least.  In the chart below, we highlight the VIX and the SP500 from July 22nd to August 8th 2011, which shows the massive increase in volatility and downside in equities that occurred as the debt ceiling debate, and a potential breach, reached its fervor.  In fact, in that period the SP500 had -16.8% drawdown.

Will the Debt Ceiling Be Déjà Vu All Over Again? - spx.vix.2011

 

Our Healthcare Team has done a substantial amount of work on the next potential breach of the debt ceiling.  In the table below, they come up with three scenarios – aggressive, base case, and conservative – that outline potential dates for the next breach in the debt ceiling.  In the aggressive scenario that date is November 28th, in the base case that date is December 11th, and finally in the conservative case the breach doesn’t occur until January 14th of 2013. 

Will the Debt Ceiling Be Déjà Vu All Over Again? - chart2

 

With the most recent budget data from the Treasury department, we are increasingly comfortable with our base case scenario in which the breach occurs before the end of the year.  Specifically, the Treasury indicated they will issue $276 billion of debt in calendar Q3 of 2012 and $316 billion in calendar Q4 of 2012.  So in total, the projected issuance will take the overall debt balance to $16.4 trillion, or $53 billion above the debt ceiling.

The debt ceiling debate last summer was about as contentious as possible and finally did reach a compromised solution, though not after creating massive confusion and uncertainty in the markets.  Given that this is an election year, it is unlikely that this issue even gets touched until after the fall elections that occur on November 6th 2012.  Thereafter, the new government will have 22 days to avert another debt ceiling crisis in our aggressive scenario.  Reaching an agreement quickly in this period is unlikely unless one party controls both the executive and legislative branches.

The electoral scenario under which either the Democrats or Republicans control both the Presidency and Congress currently appears very unlikely.  As it relates to the Presidency, Obama currently has a meaningful lead in the Hedgeye Election Indicator, he is at 57.5% on Intrade, and has a two point lead versus Romney in the real clear politics poll aggregate.  Conversely, in the most Generic Congressional poll from Rasmussen, the Republicans are up by three points.  This is validated by Intrade as well, as Intrade has the Republicans at a 51% probability of controlling the Senate and 82% of controlling the House of Representatives.

Will the Debt Ceiling Be Déjà Vu All Over Again? - Chart3

 

Clearly, a split part government is a likely scenario post the elections this fall.  As a result, so is deadlock on major issues, such as the debt ceiling.  As Yogi Berra once said, “It’s déjà vu all over again.”  This is increasingly likely to be the case with debt ceiling later this fall. 

 

 

Daryl G. Jones

Director of Research