Key takeaways
- There’s an agreement in principle in place between President Biden and Speaker McCarthy
- Neither Republicans or Democrats are happy – the deal needs to pass through the Congress and the Senate, so it’s not set in stone
- The markets are surprisingly blasé about the crisis, futures are all up on Tuesday morning
The debt ceiling crisis is nearly over, but we’re not out of the woods yet. It wasn’t a restful long weekend for President Biden and Speaker McCarthy, as the two hammered out the final details on the debt-ceiling deal and have tentatively reached an agreement in principle.
The problem now is that the deal needs to pass both Congress and the Senate, with neither side happy at the end result. They may need to swallow their pride for the good of the global economy, which would end up tanking if the U.S. was to do the unthinkable and default for the first time ever. Let’s get into the details.
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What’s the latest on the debt-ceiling crisis?
Last week the Treasury Secretary, Janet Yellen, revised her previous deadline from the 1st June to the 5th – but that’s still not a lot of extra time to make sure the deal passes in Congress and the debt repayments go through in time, so saying it’s all down to the wire is an understatement.
What’s now on the table is a two-year limit on the non-defense budget, which includes spending staying flat next year and then raising 1% in 2025. The U.S. TANF program will see changes to who qualifies for the support and SNAP is also going to have more disqualifications – both of these are likely to dominate the headlines. $30 billion worth of unspent Covid funds are being returned, but Medicaid is untouched.
The IRS is losing some funding – $20 billion, to be precise. Defense spending is set to increase to $886 billion, equivalent to a 3% rise this year, which President Biden was after as the Russia-Ukraine conflict rages on.
Both sides are declaring the deal a tentative win, but the real celebration will be the deal passing in time. The deal would suspend the debt limit until 2025, so we won’t have to go through this rigmarole again when the 2024 presidential election happens. And yet, after all of the negotiating from President Biden and Speaker McCarthy, there’s still the possibility that the deal might not go through.
Will the debt-ceiling deal pass?
Why is neither side too happy? Because it’s a compromise. The Republicans want spending cuts on education and some social programs that help low-income households to last for ten years and an increase in defense spending. The Democrats wanted tax hikes for the wealthy and for it to be easier to get approval for green energy projects – not to mention, to help more American families in need. Neither of them got close to what they wanted.
There are around 35 hardline Republicans who still don’t agree with the debt-ceiling agreement at all – and they can vote against the deal. In that case, the only way to get the deal through would be for the minority party in the House to vote for the agreement to go ahead. And if the deal does pass, it then needs to be approved by the Democrat-controlled Senate as well. Naturally, this will all happen as speedily as possible to avoid a disaster.
The deal is set for a vote on Wednesday, the first day of the week Congress is back in action after the Memorial Day long weekend. It means a lot of the vote-whipping has had to happen over the phone – and we’ll have to wait and see how effective that strategy has been.
What happens if the U.S. defaults?
A U.S. debt default could now happen as soon as next Monday. It would be the first time ever the U.S. has defaulted, and the result would be catastrophic. Debt ratings agencies Morningstar and Fitch have both already warned that the US’ debt could be downgraded, which would make it more expensive to finance.
It’s because the U.S. dollar is the world’s reserve currency, so there’s a lot riding on the U.S. economy being ultra-safe. A debt default doesn’t exactly instill confidence from the rest of the world. Immediately, $25 billion worth of federal salaries and social security checks would be delayed.
But the market reaction would be much worse: Treasury yields would spike and the stock market would crash, plunging the U.S. into a deep recession. Because of the US’ place at the top of the financial food chain, the global markets would soon follow in the same direction. Millions would be much worse off across the world and it could take years for the financial system to recover.
Thankfully, all of this is set to be avoided as long as the vocal minority in Congress are overruled by the silent majority.
The global markets’ reaction
Despite the continued uncertainty, the markets have taken the crisis in their stride this entire time and are now considering the agreement-in-principle to pretty much be a done deal.
Futures markets were slightly up on Tuesday morning. The Dow Jones Industrial Average climbed higher by 0.3%, while the S&P 500 futures gained 0.5%. The Nasdaq futures came in the highest at 1.1% up.
The stock market has held up surprisingly well amidst the turmoil, in part driven by an AI stocks rally which saw the S&P 500 close on Friday at its highest level since August last year – plus, it’s up nearly 10% this year to date. The Dow Jones has largely maintained its value in 2023, while the Nasdaq has soared nearly 25% in the same period.
As for bonds, the ten-year Treasury yield is currently at 3.74% while the two-year yield is sitting at 4.512%. Both are expected to fall when trading resumes, but uncertainty around the deal passing through Congress could throw a spanner in the works.
The bottom line
The debt-ceiling crisis comes around every so often, but rarely does it get this close to the margin. We’d like to think the deal will get through Congress and the Senate in double-quick time to avoid global financial disaster, but you never know.
Investors will be watching the proceedings closely this week to see how the deal progresses—because if the U.S. runs out of money on Monday, traders will be having a hard time in the very near future.
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