How investors are preparing for a debt ceiling standoff

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New York CNN —
The US government is set to hit its self-imposed borrowing limit today and both Wall Street and Washington are hoping for a resolution — but preparing for the worst.
The ongoing brinkmanship in Congress over whether or not to allow the federal government to borrow more money to pay its bills is bringing back memories of 2011, when debates over the debt ceiling knocked America’s credit rating down a peg first the first time in history and nearly brought the US to default, wounding both the economy and markets.
What’s happening: The debt limit, or the amount of money that the federal government is allowed to borrow, was first created in 1917 and has been raised or paused 102 times since World War II.
Now, aggressive tightening by the Federal Reserve and large spending packages have helped bring that ceiling into play once again. But Washington is at an impasse over whether or not to raise the debt limit: The White House expects Congress to pass a debt ceiling increase without conditions while Republicans say that any increase should be accompanied by spending cuts.
That stalemate presents a huge risk to the US economy and the world at large, warned the International Monetary Fund.
The global economy, ravaged by high inflation and interest rates, geopolitical chaos and a potentially widespread recession, does not need another crisis, said Gita Gopinath, the fund’s first deputy managing director, at Davos on Wednesday.
“There’s already enough uncertainty, there’s enough risks that we have to deal with,” Gopinath said during a Bloomberg interview. “This shouldn’t be an additional risk that the US or the world should have to deal with.”
Her warnings follow a stark letter from US Treasury Secretary Janet Yellen this week that said Treasury will take extraordinary measures to continue to fund the government for the next few months.
Wall Street worries: The standoff raises significant risks for investors — the greatest one being that the political stalemate results in the US government defaulting on its debt. If a default were to happen there would be “dramatically negative impacts on a wide range of financial assets including US bonds, equities and the dollar,” said David Kelly, chief global strategist at JP Morgan.
The crisis isn’t yet imminent, but investors are already preparing for turmoil, wrote David Kostin, chief equity strategist at Goldman Sachs, in a note this week.
Investors may already be hedging their bets and pricing in the impending crisis — the Dow has fallen by 1,000 points over the past two days. The S&P 500 and Nasdaq Composite also dropped significantly.
But without a resolution, steeper declines could be on the horizon. During the last major debt ceiling crisis in 2011, the S&P 500 plunged by 15% and sectors with close revenue ties to US government funding — health care and defense — dropped by 25%.
Companies with the highest revenue exposure to the US government face the most risk, said Kostin. Topping that list is Huntington Ingalls (HII), a defense technology firm, followed by Mercury Systems (MRCY), an aerospace and defense company. Big names in the health care and defense sectors like Lockheed Martin (LMT), CVS Health (CVS) and Raytheon (RTN) also have outsized exposure to federal government funds.
What’s next: “It should be stressed that it is still quite possible that, after extensive posturing, a compromise will be forged, allowing for some deficit reduction in return for an agreement to raise the debt ceiling,” wrote Kelly. But even so, he said, investors should be prepared for a “worse outcome.”
Kelly suggests that traders prepare a “debt-ceiling disaster emergency kit” which could include real assets and high-quality international stocks and bonds, denominated in foreign currencies.
Even if disaster is averted, it’s not a bad idea to keep the so-called kit on hand, said Kelly. “Given still relatively cheap overseas valuations and the current under-exposure of U.S. investors to overseas assets, these adjustments may well make sense even if Washington doesn’t trigger a debt-ceiling disaster,” he wrote.
Here come more tech layoffs
Big tech isn’t looking so great as the struggling sector amasses even more job losses. This time around Microsoft has announced plans to lay off 10,000 employees as part of broader cost-cutting measures.
What’s happening: The tech sector was the darling child of the pandemic-era. In 2021, the combined yearly revenue of Amazon, Apple, Alphabet, Microsoft and Facebook (FB) (now Meta) was $1.2 trillion — 25% higher than it was pre-Covid.
But as economies opened up and real-life interaction resumed that growth slowed. At the same time, high inflation and interest rates took a big bite out of tech companies.
Apple (AAPL) and Amazon (AMZN) each lost more than $830 billion in market value in 2022, and other big tech stocks like Facebook-parent Meta and Nvidia (NVDA), fell about 75% and 57% over the year.
Tech companies that rapidly expanded during the boom are now realizing that it’s time to downsize.
Microsoft CEO Satya Nadella said in a memo to staff on Wednesday that the layoffs were partially caused by changing demands for digital services as well as looming recession fears.
“We’re living through times of significant change, and as I meet with customers and partners, a few things are clear,” he wrote. “First, as we saw customers accelerate their digital spend during the pandemic, we’re now seeing them optimize their digital spend to do more with less.”
Layoffs abound: Multiple tech companies have made deep cuts to their workforces since the start of the year.
Amazon recently announced that it plans to lay off 18,000 people and Salesforce said it is cutting 10% of its staff. Meta also recently announced 11,000 job cuts, the largest in the company’s history.
A recent report from outplacement firm Challenger, Gray & Christmas found tech layoffs were up 649% in 2022 compared to the previous year, versus just a 13% uptick in job cuts in the overall economy during the same period.
Esther George says goodbye to the Fed
Most Americans dream of retiring by 65, but at the Federal Reserve it’s required.
The Federal Reserve Bank of Kansas City president Esther George turned 65 this weekend, triggering her mandated retirement.
So George is leaving after 40 years of Fed service. But not without some final words of wisdom. On Wednesday she delivered her goodbye speech.
“At the end of the day, trust really is our only product,” she remarked, stressing the importance of the Fed’s reputation.
George also emphasized the importance of a central bank independent of political influence. During the high inflation of the 1970s and 1980s, “it is hard to imagine a scenario where a more politically controlled central bank would have been willing to take the very difficult and painful measures that ultimately proved necessary to restore economic and price stability for the nation,” she said.
“Today, the U.S. is again experiencing high inflation and the Federal Reserve is aggressively tightening monetary policy. And, once again, the benefits of central bank independence are apparent.”
George is set to retire on January 31. Her replacement has not yet been announced.