SUMMARY
With Congress dismissing a US debt ceiling increase, President Biden has ruled out debt default. While a last-minute compromise is likely, we believe the US administration is willing to prioritize US debt payments. More fiscal restraint is also likely in any budget agreement.
- President Biden has ruled out debt default. Congressional Republicans have ruled out a US debt ceiling increase without spending cuts. While a last-minute compromise is most likely, we believe the US administration is willing to prioritize US debt payments (likely invoking the 14th Amendment), to avoid major financial consequences from missing Treasury bill redemptions and coupon payments.
- The most significant question is how much fiscal adjustment will be needed to get through this period? If the US had to live under the existing debt ceiling without new net Treasury issuance, it would have to cut non-interest spending by at least $150 billion immediately. If this was annualized, it would be a cut of nearly 7% of US GDP.
- Late payments of wages, contractor payments and Social Security benefits would generate a political backlash likely forcing a fast end to a standoff.
- The US has been raising or suspending its debt ceiling nearly annually since 1917. In 2011, the S&P 500 fell more than 15% intra-year after a particularly contentious, lastminute deal that resulted in fiscal tightening (the Budget Control Act of 2011). While not singularly responsible, federal spending fell in the next two years and rose just 3% (in nominal dollars) per year until the Covid spending explosion.
- Since the 2011 event, markets have been trained to see brinksmanship, warnings and last-minute compromises as the norm, limiting market reaction. This also may be emboldening the political theater.
- As the US Treasury bill market has been significantly distorted by the debt ceiling issue already, some market reaction is assured, with “relief” most likely. This may raise shortterm interest rates as traders “price out” a possible financial shock and Fed easing in 3Q 2023. However, the extent of any fiscal tightening that may come from a debt ceiling agreement is the key impact for the economy and markets looking forward under the most probable outcomes.
