We expect continued drama and volatility as the debt ceiling deadline approaches. As we speak, the U.S. Congress continues to negotiate the terms of a compromise that would re-open the federal government and, lift the “debt ceiling”. The debt-ceiling breach is far more important than the government shutdown. A breach could trigger chaos, but its doubtful it will happen.

What action should investors take?
Right now, do nothing. We believe that the debt ceiling will be resolved at the eleventh hour, and we expect drama. Failure to raise the debt ceiling will be disruptive.  However, those with long time horizons are advised to avoid making portfolio changes. Episodes like these are unpleasant. However, they’re also a common component of markets.

What’s at issue?
The U.S. has bills and tax receipts are insufficient to cover those expenses.  Therefore, the U.S. must issue debt to pay their bills. However, there’s a limit on how much debt the U.S. can take on. It’s called the debt ceiling.  If Congress doesn’t lift the debt ceiling, and the U.S. is unable to pay its bills, it defaults.

Is this a good way to legislate policy?
It’s very dangerous. Policymakers are putting the U.S.’s status as a “reserve” borrower and currency in jeopardy, all in a bid to extract concessions or advance a political agenda.

Is there a way out?
Essentially, it must raise the debt ceiling.

Will Congress raise the debt ceiling?
Yes, we believe it will. Policymakers are not crazy, at least politically speaking. If the U.S. breaches the debt ceiling and defaults, the blame will fall squarely on elected leaders and the political fallout would likely be severe.

What is it going to take to raise the debt ceiling?
Congress is laying the framework for a bill that provides funding sufficient to re-open the federal government for the next few months, raises the debt ceiling to allow the U.S. government to continue borrowing until early-2014. Also, a face-saving compromise at the last minute will also help.

Special thanks to our friends at Morningstar Investment Services who contributed their thoughts on the debt ceiling.

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