Debt Ceiling Deal Likely to Pass Both Chambers: May 30, 2023

Markets are breathing a sigh of relief today following an agreement by Democratic President Joe Biden and Republican House Speaker Kevin McCarthy that is likely to prevent a catastrophic default on U.S. debt. During the holiday weekend, the two leaders reached a compromise that will extend the current $31.4 trillion debt ceiling limit for two years while making cuts to federal spending. It also makes changes to a handful of policies. The agreement is now being pitched to both chambers of Congress and is expected to pass as the June 5 deadline for avoiding a debt default by extending the ceiling quickly approaches.

For fiscal-year 2024, which starts this October, military spending is capped at $886 billion and nonmilitary discretionary spending is capped at $704 billion. In the subsequent fiscal year, each would be limited to increases of about $9 billion and $7 billion. Most of the military increase would be allocated to veterans. Other provisions include the following:

• Claw back $28 billion in unspent Covid relief and shift $20 billion to nondefense items.
• Eliminate $1.4 billion in funding for the Internal Revenue Service, according to the current version, but additional cuts of $10 billion annually for the next two years are expected to be added.
• Extend work requirements up to age 55 from age 50 for the Supplemental Nutrition Assistance Program, or food stamps, and Temporary Assistance for Needy Families, or assistance intended to help families become self-sufficient.
• Reforms the National Environmental Policy Act to streamline permitting.
• Maintains current spending levels for Medicare, Medicaid and Social Security.
• Makes no changes to the Inflation Reduction Act’s funding and tax incentives for fighting climate change and promoting clean energy.
• Additionally, the deal extends the debt limit beyond the 2024 presidential and congressional election.

Markets are reflecting optimism today as the bill to raise the debt ceiling is likely to pass both chambers of Congress. Bond yields are declining sharply as the potential consequences of nonpayment and further credit quality degradation are being dismissed. The 2- and 10-year Treasury yields are down 9 basis points (bps) each to 4.51% and 3.71% while the 1-month Treasury is down 31 bps to 5.29% as investors price in on-time coupon payments from the Treasury. Equities opened up firmly in the green but are now near the flatline following last week’s astounding rally bolstered by optimism regarding artificial intelligence (AI). The same cheerfulness regarding AI is prevalent today as well, with the Nasdaq Composite Index leading the way for the major indices; it’s up 0.6% while the S&P 500 Index is only up 0.1%. Propping up the Nasdaq is Nvidia. The company’s shares are up 6% to another fresh all-time high following Nvidia’s induction to the trillion-dollar club this morning, joining the likes of Apple, Microsoft, Google and Amazon. Cyclically tilted indexes are in the red, however, as defeated risks of a recession from the default open up the door to more Fed tightening amidst a firm inflationary landscape. The Dow Jones Industrial Average and the Russel 2000 indices are both down roughly 0.3%. Crude oil is down significantly as additional interest rate hikes are likely to weigh on economic activity ahead of the OPEC + meeting on June 4. WTI crude oil is down 3.8% to $69.90 per barrel. The Dollar Index is roughly unchanged as traders weigh a higher Fed funds rate against stronger currencies out of the Euro Area and Japan.

On the economic front, data from the Conference Board this morning reflected the lowest Consumer Confidence level year-to-date. While coming in above expectations calling for 99, May’s Consumer Confidence reading of 102.3 declined from April’s 103.7. Weighing on the headline were declines in both the present situation and in expectations for the future. Surveyed consumers reflected increased difficulties in their current abilities to find work and weakening expectations of business conditions six months out relative to the prior period.

Now that the threat of an immediate recession due to a U.S. default has been sharply reduced, upside, right-tail risks in economic activity and inflation are front and center for the Fed. With odds of another 25-bp hike riding high at 66%, traders are bracing for further monetary policy restraint as Chairman Powell takes the mound on June 14. Before then, however, certain market moving economic releases are expected to move the needle higher or lower as we flip the calendar to June. Payroll Employment on June 2 is expected to come in strong, while the Consumer Price Index for May on June 13 is expected to show persistent price pressures in services.

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