Macro & Market | October 2021

Fight Over Federal Debt Ceiling Adds to Uncertainty and Market Volatility

By Robert Gahagan and Charles Tan

Key Takeaways

  • We believe Congress will likely raise or extend the debt ceiling before the December deadline given the profoundly negative consequences of default.
  • We expect continued market volatility if congressional negotiations go down to the wire amid ongoing worries about inflation and rising rates.
  • In the current environment, we think shorter-duration, higher-yielding bonds and inflation-protected securities may merit more prominent positions in well-diversified portfolios.

Investors were already worried about the upending effects of the pandemic, rising interest rates and inflation. They must now contend with the uncertainty of extreme political maneuvering over the U.S. debt ceiling.

Lawmakers narrowly avoided a partial government shutdown at the end of September by approving a stopgap funding bill. In a separate deal a week later, they agreed to a brief extension of the debt ceiling, temporarily sidestepping the potential of the Treasury running out of money. Both agreements expire on December 3.

Defaulting on the National Debt Is Unlikely

Before the extension, U.S. Treasury Secretary Janet Yellen warned the Treasury would exhaust its cash by mid-October if Congress failed to raise or suspend the national debt ceiling. The current ceiling passed in 2019 and expired in July. Since then, the Treasury has used emergency measures to conserve money.

In addition to creating havoc for domestic and international markets, default would lead to catastrophic consequences that include:

  • Defaulting temporarily on debt.
  • Delaying Social Security payments.
  • Pausing salary and benefit payments for military and federal civilian employees.

The U.S. has experienced numerous government shutdowns over the years, but political leaders have always stepped back from the brink to prevent the U.S. from defaulting on its debts. So, while lawmakers will likely wrangle until the last minute, we think Congress will resolve this issue again. No political winner would emerge from the chaos of the country’s first default.

Though lawmakers are considering massive tax and spending proposals, raising or suspending the debt ceiling doesn’t greenlight spending on new programs. Rather, it allows the Treasury to continue to pay for debts the government has already authorized. Congress approved three debt ceiling increases or extensions during the Trump administration.

Market Volatility, Higher Inflation Will Likely Continue in the Near Term

We expect volatility in the stock and bond markets while negotiations play out, and we note the shifting economic backdrop.

After spiking to its highest level in 13 years, nearly everyone is feeling the impacts of inflation. High demand, supply chain disruptions and rising costs for housing and labor are among the persistent factors causing prices to rise. We think inflation will remain elevated compared with recent years.

We’ve also seen the yield on the 10-year Treasury note continue its steady climb off pandemic lows. We expect it to stabilize between 1.75% and 2.00% this year.

What’s the Right Strategy for This Economic Environment?

Typically, rising rates combined with higher inflation can create challenges for certain bonds but opportunities for others.

For example, short-duration securities generally experience less price sensitivity than longer-duration bonds when rates are rising. Among short-duration issuers, we prefer corporate bonds that offer higher yields than government securities.

Treasury inflation protected securities (TIPS) may also merit consideration. Unlike other assets that investors have turned to as potential hedges against rising prices, TIPS tend to offer more consistent performance and automatic adjustments for inflation. Short-duration TIPS may provide a dual advantage in today’s climate by helping to reduce inflation and interest rate risk.

Higher rates and inflation affect stock portfolios as well. In broad terms, higher yields on the 10-year Treasury can make investors less willing to pay a premium for future earnings. As a result, companies that generate significant current cash flows may hold up better than businesses whose cash flows are forecast far into the future.

Meanwhile, rising inflation highlights the importance of identifying companies with strong competitive positions and the ability to pass along higher costs to their customers.

Don’t Let Headlines Lead You to Make Hasty Decisions

Volatility comes with the territory for investors. That’s why it’s so important to think about the market’s daily movements in the context of your long-term goals.

You should also ensure your investment strategy aligns with your personal tolerance for market fluctuations. And if you’re uncomfortable with how your portfolio has reacted to recent volatility, it may make sense to talk to your advisor about your strategy.


Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.