Debt Ceiling Deal Includes Two Years of Spending Caps
Strategas Washington Policy Research
Just days before the United States was set to hit the X date (at which the government could no longer pay all of its bills), policymakers reached a deal to raise the debt ceiling. In this note, we’ll break down what’s in the deal, its impact on economic growth over the coming years, and what to focus on next.
Policymakers reached a deal to raise the debt ceiling just days before the US hit the X date. The deal requires some cuts to federal spending, which will serve as a drag on GDP over the next two fiscal years, but we do not believe this is the end of the fiscal austerity narrative. Additionally, now that the debt ceiling has been lifted, there are concerns that a liquidity drain will impact markets.
What’s in the deal?
The forged debt ceiling deal includes a number of provisions. Most importantly, it raises the debt ceiling through January 1, 2025, and it imposes caps on overall discretionary spending for FY24 and FY25, cutting spending by $975 billion over 10 years. Defense spending, however, will see a 3.3% increase in FY24 and a 1.0% increase in FY25. The bill also calls for non-binding discretionary spending caps for FY26 through FY29, which, if enacted, would lead to a total of $1.5 trillion in savings. The agreement also expands work requirements in the TANF and SNAP social safety net programs, implements modest energy permitting reform, and ends the student loan payment moratorium on August 29.
What are the implications?
The binding discretionary spending cuts will result in a fiscal drag of 0.65% of GDP in FY24 and FY25, combined. Federal government spending will no longer be the support it has been for economic growth. Requiring student loan payments to restart at the end of August will lead to potentially an additional 0.2-0.4% hit to GDP, leading to less consumer spending at the same time as we move into a slower US economy (though President Biden may look to implement an income-driven repayment program in July, which could be an offset).
The deal does little to change the long-term fiscal outlook. While it does bring down costs to service federal debt to an extent, we are still expected to have net interest costs reach 14% of tax revenues this year, which is the level at which financial markets have historically begun to impose fiscal discipline on policymakers. We have not seen that level of net interest costs as a percentage of tax revenues since 1998. As a result, Speaker McCarthy announced he will establish a bipartisan commission to look at long-term spending now that the debt ceiling debate is over. We expect the US to enter a multi-year period of fiscal austerity.
A liquidity drain will impact financial markets.
Since the US hit the debt ceiling in January, Treasury has been unable to issue net new debt and has instead spent down $408 billion in the Treasury General Account (TGA) to fund government operations, which has boosted liquidity over the past several months. Now that the debt ceiling has been raised, this liquidity injection will cease as Treasury likely refills that account. If bank reserves are used to buy new Treasuries, it will be a further drain on liquidity from the financial system. We have found that increased liquidity has boosted stocks, the dollar, and bitcoin. This may reverse as the Treasury refills the TGA over the coming months.
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