This Is What The Debt Ceiling Deal Will Look Like And Why It May Be Announced As Soon As Friday
Today's daily update from Treasury showed that after a $25 billion benefits payment to Social Security, the Treasury's cash balance dropped by $27 billion to $49.5 billion, the lowest since 2021.
That means that net of roughly $80 billion in extraordinary measures (this number will have its weekly update Friday after the close), the Treasury now has approximately $140 billion in accessible cash. Which brings us to the good news: even net of the sizable cash drain on June 1 (just over $100 billion in scheduled payments) the Treasury is likely to retain a sufficient cash balance on Jun 1, the date which Janet Yellen has previously said was the X-Date, to extend operations for at least several days without a technical default.
Which, incidentally, is what we have been saying for two weeks (see "US X-Date Is Now June 5 As Treasury Burns $52BN Cash In One Day") and the Bill market today finally agreed as the May 30-June 1 Bill spread collapsed...
... and now the June 1-June 6 spread is the one to watch, which said in plain English means that the market now believes that next X-date is on or before June 6.
Of course, predicting when the next X-date is - absent more details from the Treasury - remains a challenge as Curvature's Scott Skyrm explains in his latest Repo market Commentary note (available to pro subs in the usual place):
Assuming there's no political resolution on the Debt Ceiling, the next step is to figure out how much cash the Treasury has. The Treasury projects the "X Date" to be June 1, but they're careful in their wording. And the Treasury ALWAYS projects a date that's sooner than the actual date. So what's the real X Date? The Treasury still has a small amount of Extraordinary Measures left and there's still cash in the TGA account. Economists put the combined capacity at around $40 to $45 billion through the first week in June. That means, if the projections are correct, there is enough liquidity to last to the second week. However … The problem is that $40 to $45 billion is not much of a cushion. The projections can swing by $20 to $30 billion and a surprise change can easily wipe out the excess.
That's true, and it is indeed a problem, however one can make some assumptions. As we discussed last week, our preliminary estimate put the X-date at Jun 5. Earlier today, we showed that according to a calculation by Piper's Don Schneider (full report available to pro subs), Treasury cash would drop as low as $2 billion on June 9, a level that's too close for comfort and would in the eyes of Janet .
Piper aren't the only one expecting the X-date to fall on that date: so does Goldman, which in a note late on Thursday writes that the Treasury’s “early June” deadline looks very accurate, noting that "over the last few days, the outlook for Treasury’s room under the debt limit has deteriorated slightly, though this might also reflect daily fluctuations in tax receipts that could reverse in coming days." As a result, at this moment Goldman's central scenario is that "by June 2 the Treasury’s room under the debt limit will barely exceed $30bn (the minimum cash the Treasury has targeted in prior debt limit projections) and that funds will be exhausted entirely by June 9." And in a downside scenario in which withheld tax collections slow slightly, Goldman forecasts that the Treasury would run out of funds as soon as June 6, essentially what we said two weeks ago.
Goldman's Alec Phillips then reminds us that Yellen indicated on May 24 that the Treasury will soon give Congress a more precise date than the “early June” and “as early as June 1” timing the Treasury has provided so far. Given the revised projections, it is likely that the Treasury will signal that Congress needs to raise the debt limit either by June 2 or June 5. It is unclear when this update might come, but Treasury might prefer to wait until early next week (e.g., May 30) rather than ahead of the weekend, in order to keep urgency behind debt limit talks.
For a convenient visualization, Goldman has put together a timeline with key procedural dates (top) and Treasury cash flows (bottom). While the timing of a deal announcement is hard to predict, the incentives are greatest to announce a deal late Friday May 26 or on Saturday May 27, according to Goldman. The House is on recess until June 5, but will reconvene to vote on the debt limit deal once ready. However, Speaker McCarthy has indicated that he intends to follow House rules requiring that a bill be available for 72 hours prior to the vote. Assuming a day to convert the deal into text and at least a few hours to vote on it, a deal would be needed by May 27 in order to pass the bill by May 31, leaving the Senate to pass it on June 1 (consideration of a bill in the Senate can often take more than a week, but it is unlikely to see procedural obstacles in the Senate to prevent the bill from becoming law before the deadline).
Curiously, despite the deterioration in Treasury funding, Goldman has turned modestly more optimistic on deal odds: consider that last week the bank put the odds of a full-fledged agreement by the deadline at 70% and a short-term fix at 15%, with a 10% chance that Congress fails to act in time and a 5% chance that the deadline is postponed. Now, Goldman is incrementally more optimistic (80%) on a full-fledged deal and believe a short-term patch is less likely (10%) to be needed. The bank still thinks there is a 10% chance that Congress fails to act in time (JPM is far more pessimistic at 25%), but think the odds that the deadline is pushed back are close to zero.
In the event that Congress fails to act, Goldman concedes that it is hard to predict what the White House would do, but it is slightly more likely (6%) that the Treasury would delay non-debt service payments, though it is possible that the Administration could circumvent the debt limit through a judicial ruling or through technical means (e.g. issuing high coupon/low par value notes or disinvesting internal trust funds). The next chart provides subjective odds of different outcomes.
So what would a deal look like?
While there is not much detail available regarding the potential compromise, Goldman expects the deal to include 4 or 5 things:
- A calendar-date suspension of the debt limit (as opposed to a dollar amount) that puts the next debt limit increase in mid-2025
- Caps on discretionary spending
- Work requirements on benefit programs (primarily Temporary Assistance for Needy Families, formerly known as “welfare benefits”, and possibly the Supplemental Nutrition Assistance Program, formerly known as “food stamps”)
- Rescission of unused covid funds
- Energy permitting reform
Of these, the debt limit suspension and spending caps will form the core of the deal (read below why the spending caps are a joke), with rescission of unused covid funds also very likely, while work requirements likely, and energy permitting reform uncertain.
Similar to the 2011 debt limit episode, spending caps - which Goldman has said for months will be an integral part of the deal - look likely to be central to the debt limit deal. Ironically, while the 2011 agreement capped discretionary funding for 10 years, Congress did not wait long before raising the caps. Roughly every two years after enactment, Congress passed legislation to allow for more spending.
These increases were relatively minor during the Obama Administration when Republicans controlled one or both chambers of Congress, but became larger under the Trump Administration. “Emergency” spending exempt from caps also increased later in that period (before but particularly during the pandemic).
There is another key difference with 2011 that makes this situation somewhat easier to resolve: there is no particular deficit reduction goal. In 2011, congressional Republicans insisted that each dollar of debt limit increase be matched with a dollar of spending cuts (measured over ten years). With a $2.1 trillion debt limit increase needed to last through the coming election, this meant finding $2.1 trillion in spending cuts. This year, the debt limit is likely to be suspended, rather than increased, so there is no specific dollar figure involved (extending the debt limit to mid-2025 will likely take an increase well over $3 trillion). This, along with a general lack of public attention to the fiscal outlook, has meant very little debate over the total amount of deficit reduction that needs to be achieved in any deal.
That said, negotiators still need to reach some type of spending agreement. In the current debt limit negotiations, at least four parameters regarding spending caps need to be decided:
- Spending level for FY2024: The White House has reportedly offered to freeze spending at the 2023 level. The House passed Republican bill would reduce it to the FY2022 level, a 9% nominal reduction. The middle ground could be to set 2024 spending to the 2022 level adjusted for inflation. This would allow both sides to claim a win (spending would go down slightly in nominal terms, but would be no lower in real terms than what President Biden and Democrats in Congress agreed to in late 2021). Just more theatrics.
- Length of caps: The White House has reportedly agreed to cap spending for at least 2 years. The House Republican bill would have capped spending for 10 years, but that position has reportedly been shortened to a 6-year cap. The middle ground here is clear, though the final decision will depend on other aspects of the deal, particularly the growth rate of the caps.
- Spending growth under caps: The House Republican bill proposed to grow caps by 1% (nominal) per year. The White House reportedly agreed to a 1% growth rate in the caps, though this would have applied for only one year. A 1% growth rate could be hard for the White House to agree to if the caps lasted 4 or 6 years. That said, it is likely to be lower than CBO’s baseline, which assumes discretionary funding grows at around 2.5%.
- Allocation between defense and non-defense: Democrats are likely to insist on separate defense and non-defense caps, as most Democrats support robust non-defense spending while there is greater overall support (among both parties) for defense spending. A plausible scenario is that defense could rise slightly for FY2024 while non-defense falls in FY2024, but that caps on both grow at the same rate thereafter.
The chart below shows the effect of three spending cap scenarios with the CBO baseline for comparison:
- (1) the House-passed bill, which cuts 2024 spending to the 2022 nominal level and raises the cap 1% annually for the next 9 years,
- (2) a 2-year cap that freezes spending for 2024 and raises it 1% for FY2025, and
- (3) a potential compromise 4-year cap that sets the 2024 level at the 2022 level adjusted for inflation and then grows it at 1% for the next 3 years
And if it seems like the debt ceiling "deal" will be essentially an extension of the status quo with a lot of theatrical fireworks attached, that's because - well - that's exactly what it will be: as Goldman calculates, "these scenarios look unlikely to produce a year-on-year reduction in spending of more than around 0.2% of GDP."
Putting this "deal" in context, the plan passed by the House GOP would reduce fiscal year ’24 spending by $130bn, or about 0.5% of GDP (setting aside the deficit saving from rescinding student debt forgiveness, which hasn’t been implemented yet and which may be struck down by the high court). At the other end, according to reports which indicate the White House may cap FY24 discretionary nondefense spending at FY23 levels would reduce spending by about 0.1% of GDP relative to a plausible baseline. So, the federal spending reduction for FY24 could range from 0.1% to 0.5% of GDP. The final "compromise" outcome - which may be announced as soon as Friday- will be a 0.2% spending cut.
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Finally, a few market observations.
As we have discussed extensively, debt limit-related concerns have been limited to just a few markets, primarily the short end of the Treasury curve and sovereign CDS. Yields on bills maturing on June 1 and the days that follow have cheapened substantially...
... although as noted above, the recent positive headlines have understandably led to some recovery.
The one place where the market most clearly disagrees with Goldman's rather sanguine view on the successful resolution of the debt ceiling is in the sovereign CDS which continues to reflect an elevated probability of debt default.
This, according to Goldman, is hard to reconcile with what the bank views are low odds that the Treasury is unable to make all payments and even lower odds that the Treasury fails to make timely debt service payments (i.e. prioritization).
Equities, on the other hand, have been the most sanguine of all, and market implied volatility reflects very modest risk around the debt limit deadline...
... with the rise in volatility ahead of this debt limit deadline far milder than prior episodes, almost as if stocks are certain that nothing can come out of Washington that will hurt them, and if something does, the Fed will quickly step and and intervene.
More in the full Goldman note available to pro subs in the usual place.
