Despite Delays, Debt-Ceiling Deal Still Progressing

We reiterate that investors remain in a portfolio consistent with their well-reasoned asset allocation and have the following thoughts concerning the debt negotiations.

1. Negotiations are ongoing and we believe the most likely scenario is a deal will be reached by this weekend and passed into law by June 1st. The next most likely scenario is that Congress would extend the deadline by a few weeks or months—we view this as an unlikely scenario.
2. Even if there is no deal by June 1st, the odds of defaulting on the debt are very low. Treasury would be forced to ration resources and delay other payments. Millions of Americans would be directly affected by this (Social Security checks, Federal workers not getting paid, etc.) and political pressure to reach a deal would be immense. So, even if negotiations go past the deadline, a deal is likely to be reached within hours or days of checks not going out. Importantly, bondholders would be prioritized and would get paid in any scenario—avoiding a worst-case outcome for financial markets.
3. The outlines of a deal remain on caps on discretionary spending, permitting reforms, rescinding unobligated COVID-19 relief funds, expanding work requirements for government aid, and an increase of the debt ceiling past the 2024 election.
4. It looks likely a deal will modestly cut domestic discretionary spending below last year’s levels and defense spending will be roughly flat. Congress will probably agree to caps on spending that last at least two years and probably roughly halfway between what Democrats want (two years) and what Republicans want (10 years).
5. The Republican debt-limit bill generated $120 billion in savings from safety-net programs by expanding work requirements in SNAP ($11 billion) and Medicaid ($109 billion). Republicans are seeking an expansion of existing work requirements that apply to able-bodied adults without dependents to work or attend a training program for at least 80 hours per month by increasing the age limit from 50 to 55.
6. While its uncertain whether unobligated COVID-19 relief funds will be included in a deal, the Congressional Budget Office estimates about $30 billion in budgetary savings from all the rescissions, most from the Public Health and Social Service Emergency Fund.
7. As far as energy permitting reforms, Republicans want an overhaul of the environmental permitting process (which plagues both traditional and green projects alike). Democrats are seeking changes to the rules governing buildout of transmission lines (which involves complex siting and cost allocation issues that Republicans take issue with).
8. Importantly, default is not seen as an option. Senate Republican Leader McConnell, who could start playing a more active role in negotiations, said this in the plainest terms: “Everybody needs to relax…Regardless of what may be said about the talks…the President and the Speaker will reach an agreement. It will ultimately pass on a bipartisan vote in both the House and the Senate. The country will not default.”
9. Unfortunately, neither side sees incentive to make concessions prior to the deadline. However, no one has incentive to default as evidenced by recent polling showing both sides would be blamed. Despite the political gamesmanship, we remain confident a deal will soon be reached.