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After a summer of fighting for power in Washington, lawmakers have several important decisions on the agenda this week. Among them: Deciding whether to raise the debt ceiling and avoid possible economic catastrophe.
Without a vote to raise the debt limit and extend budget discussions for the next fiscal year by Thursday night, it is likely that we will see a government shutdown and risk defaulting on the national debt.
Treasury Secretary Janet Yellen wrote this week in a letter to Congress that the Treasury would likely exhaust its means to continue paying the bills without increasing the debt ceiling by October 18.
While these don’t appear to be issues that would affect your wallet, these heated debates in the halls of Congress could actually impact your finances, from interest on your credit card debt to your investment portfolio, to money. times now and later. Here’s how.
1. Unemployment could increase
After unemployment hit a record high of almost 15% in the spring of 2020, the employment situation has gradually recovered. But we’re not out of the woods yet: the last unemployment rate was 5.2% for August, but that probably underestimates those who have dropped out of the workforce or are underemployed. For example, Federal Reserve Chairman Jerome Powell noted that the 6.5% unemployment rate in January would be closer to 10% if you counted all the people who were actually unemployed due to the pandemic.
If Congress does not raise the debt ceiling, it could slow this gradual improvement in the labor market and reverse many of the gains made since the economy reopened.
A Moody’s report last week called the default economic scenario “cataclysmic,” comparing its anticipated effects to the 2008 financial crisis. Nearly 6 million jobs would be lost, the report estimates, pushing the unemployment rate up. around 9%.
This is the worst case scenario. But even if the United States does not default on its debt, the anticipated contraction of the economy could cause some employers to delay adding positions to their payroll. It might make it harder to get a job this fall if you’re one of the 8 million Americans still out of work.
2. Social security, military salaries may not be paid
One of the biggest risks to everyday life that accompanies the threat of default is a pause in federal government payments. If the federal government defaults, it may not be able to pay the people who rely on it.
In a September 19 editorial, Yellen explained that if the United States cannot make the payments it has already committed to, nearly 50 million seniors will not get the Social Security payments they expect. in November.
In addition, people receiving veterans benefits would not receive their payments. Neither members of the military or federal employees.
Families receiving monthly child tax credit payments could go without their payments, warned Yellen – a payment system that has previously struggled to get families the correct payment amounts on time.
3. Credit card interest rates could go up
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With the evolution of the debt ceiling, there is a very real possibility that the Treasury will default on some of its obligations, which in turn would create a ripple effect felt by almost everyone in the United States who has any type of investment in the financial market or an interest-bearing loan, such as a mortgage, car loan, or credit card.
While federal tax policy may seem light years away from your monthly credit card bill, the two are inextricably linked. This is because credit card interest rates, along with the rates on other consumer loans, are tied to the health of the US economy.
In general, credit card rates are based on a combination of the Federal Reserve’s prime rate and your credit history. Someone with stellar credit will likely be eligible for a card with rates barely higher than the prime rate, while someone with bad credit will likely only be approved for a card with higher interest rates. well above the prime rate.
But both types of borrowers pay higher interest rates on credit card balances when the prime rate rises, which can happen if the Fed determines that the US economy is on volatile ground.
4. New Home Buyers May See Mortgage Rates Rise
There are two scenarios in which 10-year Treasury yields, which often move at the same pace as long-term mortgage rates, could rise if Congress does not act quickly. First, the demand for Treasuries is stagnating because investors fear that they are no longer a risk-free investment; and, second, bondholders are looking for higher rates to offset the increased exposure. In either scenario, yields would rise, which could also put upward pressure on mortgage rates.
However, if we look at history for guidance, 10-year Treasury yields could be unscathed (or even plummet) even if Congress misses Friday’s critical deadline.
In August 2011, the rating firm Standard & Poor’s downgraded the US government’s AAA sovereign credit rating to AA +. A statement from S&P called the outlook for the long-term rating “negative.”
But instead of being a haymaker for Treasuries, yields rebounded immediately after the downgrade as investors still viewed them as safe haven assets in an uncertain economy. 10-year Treasury yields fell from 2.58% on August 5, 2011 (when S&P’s announcement was made) to 2.40% on August 8, with yields falling for the next two years. It was not until June 25, 2013 that 10-year Treasury bill yields reached the 2.58% range.
Although 30-year fixed-rate mortgage rates are increasing, they are currently hovering around 3.25%, giving them room to grow while providing borrowers with relatively inexpensive borrowing costs.
5. It could upset world markets
US government debt is the foundation of the global financial system and the most widely held investment asset. It is universally regarded as ultra-low risk because the United States has never defaulted on its obligations. If the federal government does not raise the debt ceiling, the threat of default becomes very real and this low risk status is called into question.
“There are almost always political fireworks around the debt ceiling, like this time around, and sometimes they’ve even dragged on until a government shutdown,” said Brad McMillan, investment manager at Commonwealth Financial Network. Even if there was a pause in payments, government bills would still be paid, MacMillan believes.
Since the bills will be paid, the only real question is how long is the delay and what happens in between. Market volatility will be something to watch out for, and moderate declines in major indices are likely in the near term.
The S&P 500 Index had fallen about 7% in the two weeks before the S&P downgraded the United States’ AAA rating in August 2011. There was some market volatility in the following weeks. , as Congress worked out a solution, but the S&P 500 was back to all-time highs in February 2012, with the mess all but forgotten.
“It is just very important that the debt ceiling is raised in a timely manner so that the United States can pay its bills when and if they come due,” Federal Reserve Chairman Jerome Powell said during the last meeting of the FOMC. We couldn’t agree more.