Banking

‘Market angst’ brewed as debt ceiling debate raged in Congress

After weeks of Republicans refusing to vote for a bill that would prevent a default, an agreement was finally reached on 7 October, due in part to threats by Democrats to push the bill through by making changes to Senate parliamentary procedure.

The Senate eventually voted on an agreement to raise the limit by $480 billion, which will delay the debate until sometime in December. The House of Representatives is due to vote on the Senate’s bill on Tuesday, where it is expected to pass and be signed by Biden next week.

However, it seems likely the argument will be reignited in the next couple of months,  as Republicans are still refusing to come to a long term solution for the debt ceiling.

The US Treasury said it would have been unable to pay its debts by 18 October unless Congress voted to raise the amount it can borrow to pay for spending it has already committed to, which is normally achieved on bipartisan measures. 

Republicans had previously been refusing to vote for the raise, creating a dangerous game of chicken with the default date, or ‘X date’, rapidly approaching.

The debate is “raising the spectre of a US debt default”, said Clive Emery, multi-asset fund manager at Invesco. 

The US has previously experienced two debt ceiling crises, in 2011 and 2013. In the former, the Treasury came within two days of exhausting its borrowing authority, causing the credit rating agency Standard & Poor’s to downgrade the credit rating of the US Government for the first time ever.

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“The market is starting to notice, with a premium appearing on Treasury bills due to mature around the deadline,” said Gilles Moëc, group chief economist at AXA Investment Managers. 

However, Lauren O’Keeffe, consultant for Montfort Communications, noted “the costs of insuring against the US Government defaulting indeed went up a little in mid-September – but only by a few basis points and well before those scary headlines”, implying that markets were still reassured that the chance of default was remote.

A recent Bank of America report agreed, stating the debate was “largely political noise” that would likely be resolved, even if it may “go down to the wire”.

Still, it did note that “market angst” was expected, as “until markets have a clearer picture on how the Democrats intend to proceed, the issue is likely
to weigh”.

If Republicans continue to hold out support in December, Democrats may instead be forced to use the reconciliation process. This is an annual special parliamentary procedure for budgetary legislation that overcomes the supermajority normally required in the Senate due to the filibuster, instead allowing bills to pass on a simple majority.

However, Democrats are extremely reluctant to raise the debt ceiling this way, due to the procedure requiring a ‘vote-a-rama’, where each amendment must be voted on individually. Furthermore, Democrats are wary that Republicans are hoping to use a partisan vote to raise the debt ceiling as an attack line in next year’s election, especially if the vote includes a specific number to raise the limit by. 

President Biden has called the reconciliation process “fraught with all kinds of potential danger for miscalculation” and warned against it, without ruling it out entirely as a solution. 

He has also said that changing the filibuster to allow the vote to pass without reconciliation was “a real possibility”. This is likely what pushed Republicans to accept a short-term raise, as the filibuster is their main tool to preventing Democratic priorities passing the body.

Moëc said: “Our baseline is that economic and electoral rationality will prevail and that the various factions within the Democratic Party will ultimately unite to raise the ceiling through reconciliation.”

However, he noted that a default is “possible although still unlikely”.

“We might be ‘staring into the abyss’, but there are some parachutes if we fall. It is just that they are not very palatable,” he added.

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Suggestions such as minting a one trillion-dollar coin to cover the debts until an agreement is reached have been proposed. However, Treasury secretary Janet Yellen said on 5 October she opposed the idea, describing it as a ‘gimmick’ in a CNBC interview. 

She warned that the move “is equivalent to asking the Federal Reserve to print money to cover deficits that Congress is unwilling to cover by issuing debt. It compromises the independence of the Fed, conflating monetary and fiscal policy.”

A study last month from Mark Zandi, chief economist for Moody’s Analytics, found that a default could wipe out six million jobs and about $15trn in household wealth. 

It warned of a “catastrophic” fallout, estimating gross domestic product falling by nearly 4%, with the unemployment rate rising from 5% to 9%. Stock prices were predicted to crash by about one-third during the worst of the sell-off.

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