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Debt Ceiling: Crisis Averted

The debt ceiling is settled, but disruptions may yet emerge.

An ounce of preparation is better than a pound of cure.  Preparations for the worst-case scenario in the debt ceiling conflict were often intense; we are glad the contingency plans were not needed.

Our greatest fears were never realized.  A technical default on U.S. debt had no modern precedent, and could have rapidly spurred a financial crisis.  We were also mindful of repeating the 2011 experience: S&P downgraded its rating of U.S. debt, causing turmoil.  And then, the ultimate deal to resolve the 2011 standoff raised fear of an economic contraction.

This year’s Fiscal Responsibility Act (FRA) concluded the standoff with modest reforms.  The locus of the deal will limit spending for six years (the first two years of which have enforceable spending caps).  If Congress abides by the caps, the Congressional Budget Office estimates the FRA will reduce spending by a total of roughly $1.5 trillion over the next decade.  Its limited scope means its economic impact should be tolerable; Oxford Economics estimates the constrained public sector may reduce growth by up to 0.3 percentage points.

Our attention has turned to debt issuance.  While the Treasury has not announced a detailed path for raising new debt, as much as $1 trillion of securities will be needed to unwind extraordinary measures and replenish the Treasury General Account.  This will be a significant flow in a year that has already seen a high degree of volatility in the financial sector.  Money market funds have the capacity to absorb much of this issuance: over $2 trillion of money fund assets are earning a safe return over 5% using the Federal Reserve’s Overnight Reverse Repurchase (ONRRP) facility.  Money funds will purchase new bills if they are issued at rates exceeding the ONRRP rate. 

But the issuance will represent a drain on overall market liquidity at a delicate interval, as Treasury absorbs money that could have more productive uses.  Quantitative tightening means the Federal Reserve will not be a significant buyer of new debt.  If the funding comes from bank deposits or capital, it will be a further stressor on banks and all other financial intermediaries.

The episode has also taught us that the debt ceiling is now fair game to bring about fiscal bargaining.  President Biden gave up his stance of insisting on a clean lift; Speaker McCarthy made substantial compromises from his party’s initial demands.  Both sides agreed to avoid default and not touch major programs. FRA suspended the limit through calendar year 2024.  The stage is set for a renewed challenge in early 2025 if divided government persists. 

However, risking default should not feel routine.  The stakes are simply too high.  For better or worse, we expect this year’s preparation efforts will pay off in the years ahead.

 


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Ryan James Boyle portrait

Ryan James Boyle

Chief U.S. Economist
Ryan James Boyle is the Chief U.S. Economist within the Global Risk Management division of Northern Trust. In this role, Ryan is responsible for briefing clients and partners on the economy and business conditions, supporting internal stress testing and capital allocation processes, and publishing economic commentaries.

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