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Debt Ceiling Standoff

Our politicians are at it again. The Republicans are threatening to not pass the debt ceiling increase without spending cuts. Unfortunately, like most negotiations, this isn't going to be solved until the final hour. One would think that the US government would have to pay a higher interest rate due to default risk, but history suggests this may not be the case.

The Debt Ceiling Crisis of 2011 was a notable debt standoff as Standard & Poor's (S&P) downgraded the US credit rating from AAA to AA+ on August 5, 2011. This was the first time in history that the US had lost its AAA credit rating from S&P. Ironically, one would think investors would dump US treasuries, and yields would rise. But, in fact, following the downgrade, demand for US treasuries increased, causing their yields to fall.

Investors view treasuries as a "flight to safety" investment during economic uncertainty….even during a debt downgrade. This is because investors assume the US government will take steps to maintain the country's creditworthiness and will pay its debt.

Fortunately, the debt ceiling crisis of 2011 was resolved when Congress passed the Budget Control Act (BCA) on August 2, 2011, and President Barack Obama signed it into law the following day. The BCA raised the debt ceiling by $2.1 trillion, which was enough to allow the government to continue borrowing and paying its bills through 2012 and into 2013. However, the law also included provisions for significant spending cuts over the next decade, intending to reduce the federal budget deficit by at least $2.1 trillion.

Jobs, Jobs, and more Jobs

The April nonfarm payrolls rose by 253K, beating expectations of 185K, while the unemployment rate fell back to its historic low of 3.4%. Wage growth accelerated as average hourly earnings grew 0.5% m/m and 4.4% y/y. This report may reduce the odds of imminent Fed rate cuts, but the labor market is also a lagging indicator of the economy and can change rapidly once conditions deteriorate. We still expect broader signals of a softening labor market, such as declining job openings, to flow through to aggregate labor data in the months ahead.

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