stock markets
would crash and bond yields would soar. This potential self-inflicted disaster has investors on edge for the past few weeks as Democratic and Republican politicians in Washington work to negotiate a compromise ahead of an expected June 1 when the US Treasury Department runs out of money to pay its bills.
The fact of the matter is that a debt ceiling agreement will not be good news for investors or for the US economy. Republicans are calling for drastic spending cuts precisely because the economy appears to be slowing. Meanwhile, a spate of government bond issuance following a deal will drain liquidity from markets and weigh on risk assets.
“A debt ceiling agreement will result in a budget cut,” writes Jefferies chief economist Thomas Simons. “The current impasse is focused on spending cuts, and we see a good chance that Republicans will end up getting a lot of the discretionary spending cuts they want. Just like the debt ceiling debacle [in 2011,] It could be that austerity measures come at a very inopportune time, just as the economy is headed for recession.”
Big government spending cuts that Republicans are pushing could lead to slower economic growth in 2024 and beyond, depending on the details of a deal.
Advertisements – Scroll to continue
The Treasury must rebuild its cash balance in its so-called general account immediately after the conclusion of an agreement. That will mean a spate of Treasury bill issuance in early June, potentially boosting yields and pulling cash out of the system.
“If the debt limit is ever raised, [Treasury] Issuance needs to be significantly increased to rebuild TGA: that’s about $500 billion going into the Treasury account at the Fed and out of the economy,” writes Skylar Montgomery Koning, macro strategist at TS Lombard. “That means a tightening of liquidity unless there is a simultaneous sharp fall in private credit demand (which seems unlikely).”
Cash holdings in the global account have fallen by more than $500 billion since hitting the debt ceiling in January, according to government data. This has counteracted the Federal Reserve’s ongoing quantitative tightening program, which calls for $60 billion a month of Treasury bonds to be phased out. The clean-up of the account will be in addition to the QT and will add to the outflow of liquidity in the US economy. That’s a major headwind for risky assets.
All that is not to say
Shares
Advertisements – Scroll to continue
can’t recover if an agreement to raise the debt ceiling and avoid a default is announced. Virtually any deal is far better than no deal. But it will not be an all-clear signal for markets beyond a near-term recovery.
Write to Nicholas Jasinski at [email protected]
Comments are closed.