The Year of the Rabbit is off to a hoppin’ good start in the markets. As of the end of January, the S&P 500 is up more than 6%, the DJIA is up about 3% and the NASDAQ is up more than 10%. In fact, stocks hit what’s called the “January Indicator Trifecta” — gains in the seven trading days around the new year, gains in the first five days of the month, and gains for the month overall. Even US bonds are showing signs of life, with gains of 2–3% year to date. A decline in consumer spending and inflation, as well as softening home sales, point to signs of a slowing economy, and that gives many hope that the Fed will continue easing up on future interest rate increases. Some experts are even starting to think that the economy might achieve that soft landing, especially after the latest gangbuster jobs report which made it that much more likely that we'll avoid a recession.

But above all of that cautious optimism looms a dark cloud: the US government’s debt capacity, and the possibility — however remote — of a US government default if Congress can’t come to an agreement and lift the debt limit. We’ve been here before — 78 times, in fact, since 1960 — but will this time be different? 

What exactly is the debt limit?

The debt limit, also called the debt ceiling, is the maximum amount the US government is legally allowed to borrow to meet its spending needs and obligations. Just like individual consumers can only borrow so much from a bank to buy a home, or only put so much on a credit card, the US government has a limit on the amount it can legally borrow. 

The current maximum is $31.381 trillion, which was set in December 2021. Once that ceiling is reached, and all “extraordinary measures” (ie, certain accounting maneuvers) are exhausted, the US government would have to default on its obligations — things like interest on US Treasuries, salaries for federal employees, and benefit payments like Social Security and veterans’ benefits. 

Congress has the power to raise the debt ceiling, but Republicans and Democrats can’t agree on how to get there. Republicans don’t want to raise the limit until Congress commits to cutting spending, but Democrats believe this isn’t the time for those negotiations and want to raise it unconditionally. 

Historically, the US has almost always run a budget deficit. Although numbers in the billions and trillions are extraordinarily large, such spending can be supported by rising economic growth. Instead of looking at the absolute dollar amount, it’s useful to think about the budget deficit relative to gross domestic product (GDP), a measure of the nation’s economic output. The chart below illustrates this relationship over time. While we are currently running a deficit relative to GDP, the deficit is also not the worst it’s ever been.

However, with the economy slowing, the question is whether there will be enough growth to support increased federal spending. 

The “extraordinary measures” currently being used to allow the US government to keep paying its bills are expected to run out mid-year. Whenever this happens, the two sides of Congress tend to play a game of stare-down, waiting until the last possible second, and sometimes even longer, to finally blink. In the meantime, the markets are left hanging with uncertainty, which can lead to more volatility. In 2011, Congress’s inability to negotiate an increase in the debt ceiling led the US government’s top AAA credit rating by S&P to get downgraded, and the S&P 500 dropped 17%.

Today, while the economy is improving, it’s still fragile. Some economists believe a US default would be catastrophic and could cause a global recession. Still, it’s worth noting that the US has never defaulted on its debt, and it’s doubtful that any elected official would want to place the US and its citizens in such a precarious situation.

But there is one thing Congress has agreed on

And that’s SECURE 2.0, an act meant to help strengthen the retirement security of all Americans. While we can’t control what happens in Congress, we can be the pilot of our own retirement. 

In case you missed it, here are a few highlights from SECURE 2.0:

• The age at which retirement account owners are required to start taking required minimum distributions (RMDs) will increase from age 72 to age 73, and again to age 75 starting in 2033. While this may be far down the road for many (or perhaps not), the extensions give account balances more time to stay invested and grow, plus additional flexibility for accessing different accounts in retirement.

• Starting in January of 2025, catch-up contributions (extra contributions that older investors can make to their retirement accounts) for investors age 60 through 63 increase to $10,000 from $7,500. There are some caveats for higher-earning workers, so be sure to check with an accountant to determine what’s available to you.

• If you contribute to a 401(k), you may soon be able to contribute after-tax dollars to an emergency savings account, up to $2,500 a year starting in 2024. You’ll be able to draw on those savings if needed, without taxes or penalties.

• There are also updates on 529 plans and employer assistance with student loan debt set to begin in the next few years — so be sure to work with your tax professional to understand whether any of the changes benefit you.

As a person of Asian descent (and one who was born in the Year of the Rabbit), I’ve spent time reading about what the Year of the Rabbit might have in store. I was happy to learn that 2023 is one of self-reflection, empathy, balance, hope and peace. Jonathan H. X. Lee, an Asian and Asian American studies professor at San Francisco State University, says: “There needs to be a moment of introspection and thoughtfulness in being, in action, and for the intention of long-term success.” When it comes to investing, I couldn’t agree more. (And I hope our representatives in Congress got the Rabbit’s memo, too.)

Disclosures