Debt Ceiling Fallout – The Winners, The Losers and What It Means for the Markets

In January 2023, the U.S. reached its debt ceiling, and Secretary Yellen announced that the Treasury would begin taking “extraordinary measures” to avoid defaulting on any U.S. obligations until a bill passed to increase the debt limit. Such measures have become relatively common over the last two decades. During that time, the risk of defaulting on debt as the limit neared had become a political negotiating tool. While experts argue that raising the debt ceiling should not be a tactic for setting spending policy, such negotiations have become the norm.

In April, Republican House speaker Kevin McCarthy secured enough support from the fractious Republican House membership to pass a debt-ceiling bill that would increase the debt ceiling until March. The bill included spending curbs that would derail many Democrat priorities and would not garner enough support to pass Congress. It represented an important step towards negotiations though.

Following the bill’s passage, Democrats softened their position of only supporting a “clean” debt ceiling bill – one without any of the spending concessions that Republicans were seeking. But, in the eleventh hour, a default was narrowly avoided. Did either party come out on top? What implications, or repercussions, should we expect this situation to have on the markets?

While neither party showed an eagerness to compromise on budget concessions, both ultimately made sacrifices to get a deal done. Republicans voiced that the deal didn’t cut enough spending. Conversely, Democrats believe the Republican party didn’t sacrifice enough and were willing to target reductions among social programs that benefit vulnerable Americans.

Before we can identify winners and losers, it’s important to understand the key inclusions of the bill. A few takeaways include –

·       A suspended borrowing cap until January 2025

·       A cap on non-defense spending in fiscal 2024. Set to increase by 1% in 2025. 

·       Maintain protection for veterans’ medical care

·       Stricter requirements for food stamps program

·       Rescinding COVID-19 relief funds

·       Cuts to IRS funding

·       Maintain the Inflation Reduction Act’s climate and clean energy provisions

·       End Biden’s student loan repayment freeze

A closer look at these budget concessions and it appears compromise was fairly even across the board. Some consider President Biden a winner in this scenario, simply because of his ability to get a deal done that averted the severe cuts initially approved by House Republicans. He delivered a bipartisan deal, something he touted as a priority during his presidential campaign in 2020. Undoubtedly, he’ll lean on this narrative heavily in his reelection campaign heading into 2024.

On the other hand, McCarthy comes out as a winner and a loser. Here’s why. He parred the proposal down enough to successfully strike a deal, making him a winner. But did he remain firm enough on spending curbs to keep the support of the House? When heading into negotiations, McCarthy had a stronger hand but didn’t play it well. Most of the Republican party saw fewer concessions than expected, criticizing the outcome – not to mention 71 defections from the Republican side. McCarthy finds himself in a vulnerable position as House speaker. If enough Republicans show dismay, the political consequences could be severe and it’s possible for a no-confidence vote to be held, further jeopardizing McCarthy’s position.

If an agreement had not been reached, a default would have been disastrous and sent the economy into a tailspin. However, the markets aren’t clear just yet. Over the next several months, we’ll see an uptick in treasury bill issuance to replenish the government’s coffers. The sentiment is split on whether this is a viable concern to the markets. Yet, this will cause a drain on liquidity and the markets may not be prepared. The Fed’s tightening has eroded bank reserves and a looming recession has led to money managers hoarding cash. Treasury borrowing could exceed $1 trillion later this year but it’s hard to say what the implications will be, but only time will tell.