Debt Ceiling Tracker: A Good Deal for the White House, Less So for the Fed

Summary

• The deal agreed over the weekend leaves the Democrats well positioned for the 2024 elections but does little to stabilize the economy.

Deal Removes Debt Ceiling Risks Until After 2024 Elections

The deal agreed between President Biden and House Speaker McCarthy suspends the debt ceiling until January 2025 in exchange for a $81bn or 0.3% of GDP expenditure cut relative to the CBO FY2024 baseline and a $68bn increase relative to FY2023.

This is how I arrived at this number (Table 1; deal details):

1. No adjustments to the FY2023 budget; all the cuts happen in FY2024 and beyond.
2. The deal leaves mandatory expenditures (social security, Medicare, Medicaid, etc.) unchanged. Those account for 60% of total expenditures.
3. The deal includes an FY2024 increase in defense spending to $886bn, $34bn above the CBO FY2024 baseline and $94bn above FY2023. Military spending represents about 45% of discretionary spending and about 10% of total spending.
4. The Republicans claim that non-defense discretionary spending has been capped to FY2022 levels, while the White House claims that, after factoring in appropriation adjustments, it has been capped to FY2023 levels. I have assumed that it will be an average of these two levels or $884bn, that is, $115bn below the CBO FY2024 baseline and $35bn below FY2022 levels. Non-defense discretionary spending accounts for about 15% of total expenditures.
5. If it turns out that the Republicans’ assessment is the correct one, FY2024 non-defense discretionary spending would be $150bn below the CBO FY2024 baseline  and $71bn below FY2023 levels.   
6. For simplicity, I have assumed that interest spending remains at the level of the CBO May 2023 forecast.
7. In FY2025, the increase in non-defense discretionary spending would be capped to 1%.  After 2025 there are no budget caps, only ‘non-enforceable’ targets. 

The deal does not address the FY2023 shortfall in revenues, about $250bn relative to the CBO February 2023 forecast. 

The deal also leaves in place the White House student debt forgiveness plans, though they seem more likely than not to be struck by the SC – a ruling is expected by the end of June.  Because of accounting rules, the NPV of the forgiveness, $379bn or 1.5% of GDP, was included in FY2022 expenditure and a strike by the SC would reduce FY2023 expenditures by an equivalent amount. This would not impact government issuance much since the impact of the forgiveness on government cashflows would have played over the long duration of the loans.

Student loan repayments were expected to restart at end-August and the deal forbids a further extension of the moratorium (payments have been suspended since March 2020).  The administration planned changes to income driven repayment plans remain. They are expected to reduce debt service at least by half. Additional measures to address administrative failings of the current system could further lighten repayments.

The debt ceiling deal also includes provisions on work requirements for welfare recipients, as well as energy and infrastructure permitting reform.

Deal Does Little for Economic Stabilization

I did not expect a deal so soon largely because I did not expect Speaker McCarthy to make so many concessions. Basically, the deal moves the debt ceiling until after the 2024 elections in exchange for expenditure cuts that are too small to noticeably impact growth and unemployment. The limited scope of the deal could reflect both parties’ reluctance to tackle entitlements or cap defense spending, as well as the small share of non-defense discretionary spending in total expenditures. In any event, the deal leaves the Democrats well placed for the 2024 elections. 

The deal still has to be passed by Congress, and the House Freedom Caucus has already signaled its opposition. But as it stands, the deal is likely to garner enough Democratic support to pass both House and Senate.

Overall, the deal removes the uncertainty surrounding the debt ceiling with only a limited decrease in expenditures. The FY2024 deficit remains 5.7% of GDP, about the same as the CBO FY2023 projection. Fiscal policy therefore remains highly accommodative (Chart 1). And it leaves most of the burden of stabilizing the economy to the Fed. Following the deal, I expect a 25bp hike at the June 2023 FOMC meeting.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF, and the World Bank. She joined Macro Hive soon after its inception.

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)

• Share article on:
• an app
• LinkedIn
• Facebook
• Twitter
• email

Your comments