US Debt Ceiling: Done Deal (?)

An agreement on the urgently needed raise of the debt ceiling in the US appears to be on the horizon. President Biden and the Republican chief negotiator Kevin McCarthy agreed on a compromise solution. However, this must be approved by Congress in the near future, as latest estimates point to a default as of June 5.

Agreement found, but inception of the policy not yet fixed

The self-imposed debt ceiling of the US must be raised if reached, otherwise the economy will no longer be able to service existing liabilities. This would represent an unprecedented, potentially catastrophic scenario for the world economy and global financial markets. However, after intensifying negotiations, the Democratic and Republican negotiating teams were able to agree on a compromise solution. This provides for a suspension of the cap until January 1, 2025. Such a suspension has been used with increasing frequency, especially in the last decade. In return, on the spending side, non-defense spending is to be kept at the current year's level, while defense spending can be increased by up to 3%. Further, some federal aid programs are to be made subject to stricter working requirements, and the moratoria currently in place for student loans are to be ended. A new funding structure for the Internal Revenue Service was also approved. This selection of agreed-upon measures illustrates that the draft represents a compromise solution among the parties involved.

However, the proposal must still pass the Congress, which consists of the Senate and the House of Representatives, before President Biden can finally seal it with his signature. This must happen before June 5, which is the latest estimate of the US's default-date. Two factors could prove to be a problem in this regard. First, the review of such a document naturally takes time. House representatives, for example, have up to 72 hours to consider proposed legislation before it comes to a vote. Second, Republican hardliners from the so-called “Freedom Caucus” in particular have already announced their intention to block the agreement. Given the rather narrow majorities in the chambers of Congress, finalization of the introduced proposal could accordingly stand on shaky ground. Nevertheless, we think that majorities voting for the proposal will be found eventually, and that a default of the US can thus be averted.

On interest rate markets, the discussion about the debt ceiling can best be followed on the CDS market, where investors insure themselves against a US default. CDS spreads have widened significantly in the course of the tough negotiations and the associated uncertainty. Already in anticipation of a solution, these have fallen from 270 bp to below 200 bp (6M). A further drop in the course of the official agreement in Congress is likely. The same applies to very short maturities of the US Treasury yield curve (1-3M). In the broad US Treasury market, yields have started the week at slightly lower levels, suggesting a positive reaction. However, the agreement is in line with broad market expectations and, in general, it is important to emphasize that the debt ceiling issue received broader media attention than financial market attention, where the topic is a very uncomfortable tail risk.

On the stock markets, the preliminary breakthrough in the debt dispute was already largely anticipated on Friday — especially in the US. Yesterday, the impulses from this hardly provided any more support on the few European stock exchanges that were open. With the exception of China, virtually all of Asia's stock indices managed a gain on Monday; in Europe, however, the gains made at the beginning crumbled in the course of trading and the Euro STOXX 50, DAX and ATX each closed between 0.2% and 0.4% lower. However, it should be noted that stock markets around the world had already taken the debt dispute lightly in the run-up (even if media reports could have given a different impression). We remember: On 19 May, for example, the DAX reached an all-time high (!). In this respect, even if the outcome of this temporary negative factor is finally positive, we do not necessarily have to expect new, too large price jumps.

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Markus studied economics at the Vienna University of Economics and Business and at Tilburg University. He joined Raiffeisen Research's Economics, Rates & FX team in late 2022 after multiple prior internships in the banking industry. Due to his academic background, he puts his main focus on the quantitative and qualitative analysis of global economic developments. Beside his interest in economics and finance, Markus is particularly enthusiastic about strength sports and football.

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Franz ZOBL

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Franz joined Raiffeisen Research's Economics, Rates, FX team in 2020 primarily focusing on US monetary policy, benchmark yields and EUR/USD. Prior to joining RBI, he worked as a research economist in the financial sector. He holds a PhD from the London School of Economics and studied at the Vienna University of Economics, the University of Vienna as well as Tilburg University. He is a published author within the field of macroeconomics and has a passion for economic history.