Both President Biden and Congressional leaders expressed guarded optimism that a potential deal could be reached by the end of this week after Treasury Secretary Yellen reaffirmed the “X-date”—1 June—as the expected default deadline when the US Treasury may begin to fail on its obligations based on the latest tax receipts. If Yellen is correct, there are fewer than 15 days until the US Treasury Department defaults.
Although stocks have gained on brief bouts of optimism, the market is sensitive to the waning confidence that lawmakers will reach an agreement in time. Investor concerns over the debt ceiling are reflected in the latest four-week Treasury auction (maturing on 9 June), with yields notably above those of longer-dated Treasurys (exhibit 1).
Exhibit 1: The latest Treasury auctions
Against this backdrop, details about what a final deal may look like are beginning to take shape. While House Democrats seek to collect signatures to launch a discharge petition that would force a clean debt ceiling vote, this is likely a long-shot bid. We believe a final deal will ultimately be a two-track process:
- A clean debt ceiling increase through at least the 2024 election coupled with,
- Comprehensive policy agreements on four main areas:
- Budget caps
While Republicans are pushing for nearly a decade’s worth of budget caps, Democrats are only seeking two years’ worth of caps. We believe the final deal will likely land somewhere in between—not unlike those made in 2011 which avoid naming specific departments and programs - Covid-19 relief claw-backs
Both parties seem willing to rescind unspent Covid-19 relief money—some estimates peg this as high as $60 billion. - Tougher work requirements for certain federal programs (excluding Medicaid)
President Biden indicated he may be willing to toughen work requirements for certain federal aid programs (excluding Medicaid), therefore, stricter requirements may be included in any final deal. - Permitting reform has also been included in debt ceiling talks with both parties looking to speed up the approval process for energy projects and reduce unnecessary delays.
- Budget caps
We continue to estimate a 33%-50% chance of a selective default where the US Treasury Department continues to make interest and principal payments on its existing debt but withholds other payments such as Social Security benefit payments, Medicare/Medicaid payments, wages to government employees (including members of Congress, TSA employees, members of the armed forces, etc.), tax refunds, and payments to government contractors. The political pressure in such a crisis scenario will likely serve as the impetus to any bipartisan agreement.
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