Debt Ceiling Debate

Debt Ceiling Debate

There’s a deal! There’s not a deal! Does it really matter?

On Saturday, House Republicans and the White House said an agreement on the debt ceiling had been reached in principle. There doesn’t seem to actually be a bill written yet, but some politicians are already saying the deal won’t pass.

Again, there’s no bill out there, right now, but the claim is that it raises the debt ceiling by $4T for two years, rolls back non-defense discretionary spending to ’22 levels, and has no budget caps after 2025. There are, of course, many other details, like cutting some recent IRS funding and no new taxes, but the above seems like the basics. Honestly, I’ve been running into so many different variations of what the deal says that it’s hard to say much about it with any great confidence.

Some Republican politicians don’t think this deal is good enough. $4T in spending doesn’t reflect fiscal responsibility, at least to them, and they won’t vote for this deal. We’ll see what happens, but at least 34 House Republicans are against the outline of this deal. Some Democrats also aren’t happy about the deal, saying it doesn’t reflect Democratic priorities.

Ultimately, is the debt ceiling good news for markets? On the bright side, a debt deal allows the government to continue functioning, and that is part of our economic engine. On the downside, the Treasury has been drawing down its balance sheet all year, which has helped stimulate markets. When a debt deal comes, that stimulus reverses, as the Treasury will effectively take money out of the market to bring their balance sheet back up. That’s estimated to take over $700B in the next three months and a total of about $1.25T for the year. That can effectively shrink money going into the market and also further stress bank funding.

The common thought is that both sides have counted the votes, so this should pass. I’m not positive. Debt negotiations have often been rancorous, and it’s possible this is more about cosmetics than progress. Both sides can say they tried, other parties prevented the deal, and go from there. We should see which way it goes this week.

The calm in the stock market seems odd. Treasury markets are getting hit a bit, as are FX markets, but the stock market is busy flooding into AI-oriented names at questionable valuations. After we had the debt ceiling resolution in 2011, the stock market dropped by 12%. I struggle to see why we shouldn’t expect something similar, here.

There are also secondary issues. In 2011, S&P downgraded the US sovereign debt after the debt ceiling fight. Now, Fitch is talking of doing the same. Having two major rating agencies say the US debt isn’t AAA credit could cause selling where AAA ratings are required. It would also downgrade the average rating of many portfolios.

I’m just having a hard time being constructive here. If a debt ceiling deal isn’t reached soon, we should see broad concerns about markets and the economy. If we do get a deal, history tells us that’s market negative. People can continue to chase and throw money into this market, taking it up, but I currently struggle to see a fundamental or macro basis for investing right now.