The Debt Ceiling Issue Could Roil Markets: The VIX Could Be Too Low

John Maynard Keynes was an English economist and philosopher. Keynes’s ideas fundamentally changed the theory and practice of macroeconomics and the government’s economic policies. Keynesian economists believe the rigidity of prices makes fluctuations in any spending component, including consumption, investment, or government expenditures, cause output to change. For example, when government spending rises, and other spending components remain constant, output will increase.

Keynes once wrote, “If you owe your bank a hundred pounds, you have a problem. But if you owe a million, it has.” Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment. Meanwhile, a country’s gross government debt is the financial liability of the government sector. Government debt occurs when expenditures exceed revenues. In early May 2023, the U.S. government debt was over $31.7 trillion. The current U.S. debt ceiling stands at $31.4 trillion, and the Department of the Treasury has undertaken” extraordinary measures as it waits for the legislative and executive branches to increase the ceiling.

The VIX index measures the implied volatility of options on S&P 500 stocks. Options are price insurance, and the demand for insurance rises when stocks fall as market participants seek protection. At below 17, the VIX could be far too low in the current environment.

The debt will rise even if spending and revenues are balanced

• The Fed Funds Rate is now at the 5.125% level after rising from zero in March 2020.
• Funding the U.S. debt of $31.7 trillion now costs over $1.62 trillion annually if spending and receipts are equal.
• Compounding interest is a problem that will cause the debt to increase exponentially unless U.S. revenues exceed spending.

A hot-button political issue in May 2023

• The slim Republican majority in the House of Representatives has proposed spending cuts and an increase in the debt ceiling.
• The Biden administration has refused to negotiate with Congress over increasing the debt ceiling.
• The standoff could lead to a debt default without compromise.

A default would be unprecedented

• The U.S. has never defaulted on its debt obligations.
• The S. Treasury Department warns, “The scope of the negative repercussions related to a default are unknown but would likely have catastrophic repercussions in the United States and in markets across the globe.”
• As the standoff nears a deadline for the debt ceiling between July and September 2023, the market impact could begin to emerge.

Markets are calm- A threat of default will change that

• Stocks, bonds, currency, commodity, and cryptocurrency markets are calm in early May 2023.
• The summer vacation period tends to be quiet in markets as liquidity declines.
• The debt ceiling issue could make the 2023 summer a very volatile period.

The VIX is low- Expect spikes over the debt issue

• The VIX is the stock market’s insurance premium.
• The VIX fell to 15.53 on May 1, the lowest level since late 2021.
• The debt ceiling standoff that increases the potential for a U.S. default could cause a spike higher in the volatility index.
• The VIX could be too low in the current environment.