Debt-Limit deal ends threat of US default

Bipartisan deal reached to suspend US debt ceiling, mitigating financial crisis risk

By Ahmed Azzam | @3zzamous | 2 June 2023

US Dollar Index is awaiting the Federal Reserve-5
  • Senate passes legislation to suspend US debt ceiling and implement spending restraints

  • President Biden to sign the bill, avoiding a looming US default

  • Market sentiment improves as investors shift focus to Federal Reserve policy

  • Spending caps and provisions for federal spending set for the next two years

In a significant development, the US Senate has successfully passed legislation to suspend the debt ceiling, effectively averting a potential global financial crisis. The measure, which also includes provisions for imposing spending restraints, awaits the signature of President Joe Biden. The bipartisan support received for the bill underscores the urgency to avoid the disruptive consequences that a default could unleash.

This milestone achievement comes after intense negotiations in a highly polarized political landscape. Moderates from both parties played a crucial role in ensuring the bill's passage, prioritizing the need to prevent a default over their reservations about certain aspects of the deal.

The 63-36 vote on the bill was carried by moderates in both parties, many of whom aired their misgivings about parts of the deal but were convinced that their concerns weren’t worth risking the havoc a default would unleash.

Market sentiments respond positively as default risk subsides

Market sentiments have responded positively to the news, as investors have assessed the risk of a US default as resolved. Attention is now shifting towards other market uncertainties, with the focus turning to Federal Reserve policy. Futures on the S&P 500 and Nasdaq 100 have displayed upward movement, while the dollar has extended its recent decline. Treasury yields, on the other hand, have experienced a slight decrease.

This legislation stands out as a rare accomplishment in the current political climate, characterized by deep divisions and limited deal-making prospects. It required weeks of private negotiations and public debates to strike a compromise. The compromise was achieved through diligent deliberations between the two parties, with Senator Kyrsten Sinema playing a crucial role in bridging the divide.

To address concerns raised during the negotiations, the Senate agreed to expedite votes on various amendments, although all of them failed. Additionally, statements from Senate Majority Leader Chuck Schumer were aimed at assuaging apprehensions regarding defense spending levels and potential cuts. Schumer emphasized that the spending caps outlined in the bill could be bypassed in urgent cases, such as defense and domestic priorities, through emergency funding, subject to the approval of the Republican-controlled House.

Political costs and implications of the debt-limit deal

The successful passage of the bill in the Senate marks the end of a prolonged standoff over the US debt, but it comes with political costs for both President Biden and House Speaker Kevin McCarthy. Criticism has emerged from within their respective parties, suggesting that too many concessions were made during the negotiations. McCarthy, in particular, has faced intensified scrutiny from the ultra-conservative House Freedom Caucus, leading to discussions about potential measures to remove him from his position.

While the vote carries the risk of alienating progressive members of the Democratic party, President Biden's focus remains on avoiding an economic upheaval as he approaches his reelection campaign. The agreement not only averts a crisis but also bolsters Biden's image as a pragmatic leader willing to foster bipartisan cooperation.

The legislation paves the way for federal spending over the next two years, effectively suspending the debt ceiling until January 1, 2025, and pushing another borrowing clash beyond the presidential election. In exchange for Republican support on the debt ceiling suspension, Democrats have agreed to cap federal spending for the same duration. Furthermore, the bill includes approval for Equitrans Midstream's Mountain Valley Pipeline project in West Virginia, which had previously encountered delays.

As the spending restraints outlined in the deal take effect, there could be notable implications for various segments of the population. Young college graduates will face the resumption of student loan payments, while lower-income Americans may experience benefit restrictions or service cuts. Experts caution that the spending caps, while offering short-term stabilization, do not address the long-term challenge of the unsustainable trajectory of US federal debt.

The specific adjustments to government services resulting from the spending restraints will be determined through separate negotiations in Congress. These negotiations, slated for completion before the start of the next federal fiscal year on October 1, will play a vital role in shaping the impact of the legislation. The Congressional Budget Office estimates that the spending caps

The two-year spending caps called for in the agreement will deal an additional short-term blow to an economy already vulnerable to a recession. Yet they’ll barely dent the unsustainable medium-term trajectory of US federal debt — which we estimate is still on track to rise from 97% of GDP in 2022 to more than 130% of GDP by 2033.

A bipartisan effort secures economic stability and averts a financial crisis