Market Update: A Debt Ceiling Deal Takes Shape


John Micklitsch, CFA CAIA, President & Chief Investment Officer
Kevin Gale, Managing Director, Head of Fixed Income

With the outline of a debt ceiling deal in place, the U.S. appears to have narrowly avoided a potentially historic unforced error that would have reverberated for decades. Failure to pass a deal could have resulted in the first default on Treasury securities in U.S. history, resulting in higher borrowing costs, less reliance on the U.S. dollar throughout global trade and a loss of credibility that would have potentially shaken the reputation of the U.S. in geopolitical circles for generations. In the end, compromise was found, as is often the case, in the middle with both sides of the aisle left to complain. Yet, the stakes were just too high not to find a way to make a deal.

What the debt ceiling deal does:

  • Avoids a default on U.S. Treasury securities
  • Takes another debt ceiling showdown off the table until after the 2024 presidential election
  • Caps spending (flat for two years with no inflation adjustments)
  • Protects defense spending at 3% growth
  • Streamlines the permitting of some energy projects including fast-tracking the construction of a new natural gas pipeline championed by Democratic Senator Joe Manchin of West Virginia
  • Claws back some pandemic-related unspent funds
  • Creates stricter work requirements to receive Federal assistance
  • Installs a hard mandate for student loan repayments to restart “60 days after June 30, 2023” 

What the debt ceiling deal does not do:

  • Does not resolve the highest debt-to-GDP ratios in the U.S. since the 1940s
  • Does not cut actual spending (just holds it flat for two years, not ten years as originally contemplated)
  • Does not create new taxes
  • Does not touch Social Security or Medicare
  • Does not eliminate additional funding to the IRS (cuts it from $80 billion to $60 billion)

What is left at this point:

  • The House of Representatives reviews for 72 hours, culminating in a final vote on Wednesday, May 31st at the earliest
  • The Senate votes on the deal thereafter
  • Theatrics, but given the stakes and compromises in the bill, this is unlikely to be a party-line vote, so we would be shocked (as would markets) if it wasn’t approved

Market implications:

  • Near-term, the market is relieved that the worst-case default scenario appears to have been avoided
  • Ultra short-term treasury yields (one-month and shorter) are likely to rally (price up, yield down) as the threat of default on these particular issues is alleviated
  • The Treasury is likely to issue upwards of $1 trillion of T-bills over the coming months to replenish its coffers, which could keep upward pressure on short-term rates
  • The market’s focus will likely shift back to inflation, Federal Reserve policy, the economy’s resilience and geopolitics

There will never be a lack of wall-of-worry items at any point in time, but the debt ceiling showdown is another illustration that in the end the U.S. usually finds a way to compromise, worst-case scenarios rarely are the ultimate outcome despite our fears (as is often the case in life) and that maintaining an appropriate perspective, even in the face of near-term challenges, remains a time-tested and successful approach to achieving favorable, long-term investment outcomes.

Please reach out to your Ancora team if you have any questions, comments or concerns that we can address.

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