June 30, 2019
Luis Alvarado, Investment Strategy Analyst
Peter Donisanu, Investment Strategy Analyst
Charlotte Woodhams, Investment Strategy Analyst
Debt, Democrats, and Dollars
A bipartisan deal has been reached to raise the debt ceiling and increase spending levels. If the deal becomes law, it will remove an uncertainty that had been weighing on the market.
- A deal to raise the debt limit and increase spending caps has been reached. We expect the bill to be signed into law over the next few weeks.
- While budget appropriations will still need to be passed to remove the threat of a government shutdown this fall, we believe that this deal smooths the political path and removes an uncertainty from the market.
- We favor retaining exposure to equities and fixed income as part of a diversified portfolio (and in alignment with strategic objectives). If volatility rises in coming weeks due to congressional inaction, it may present a compelling opportunity to rebalance and purchase quality holdings.
A deal is reached—federal debt limit extended until July 2021
The U.S. government has been running a fiscal deficit for some time (spending more money than it collects). Issuing debt to fund federal spending obligations is a routine Treasury Department task. The U.S. debt limit set by Congress limits the amount of debt that the Treasury Department can issue. The federal debt limit does not authorize new spending commitments. It simply allows the government to finance existing obligations that Congress and the president have agreed to fund in the past.1
In February 2018, the Bipartisan Budget Act of 2018 suspended the federal debt limit through March 1, 2019. At the time, Treasury Secretary Steven Mnuchin sent a letter informing Congress that the Treasury Department would begin taking “extraordinary measures” to continue funding the government and to prevent the U.S. from defaulting on its obligations.
The available funding from these extraordinary measures was projected to expire in September 2019. If congressional leaders and the president follow through on their commitment to approve the new budget and debt deal, the debt limit will be suspended until July 2021. The deal also removes the threat of sequestration by raising spending by $320 billion over existing spending caps. The increased spending would likely push the annual budget deficit above $1 trillion per year. The spending increases will be offset by only $77.4 billion in spending cuts. Budget hawks seem to have lost their voice in the current political climate.
While spending levels have been agreed upon, the actual appropriations that direct and allow the government to spend money still need to be passed once lawmakers return from their summer recess to keep the government open. In agreeing to the new spending, lawmakers have committed to keep any poison-pill language out of the appropriations bills, which reduces the threat of a government shutdown this fall.
In our opinion, the markets are not discounting a federal government shutdown or further budget-talk gridlock. If hints unexpectedly appear that a shutdown or budget gridlock may occur, we could potentially see a sell-off in U.S. risk assets (such as equities and high-yield debt), along with increased Treasury yield volatility. Yet, we believe that investors have learned from previous government shutdown episodes, and they may be more reluctant to sell risk assets as they seek to avoid missing out on any upside from a post-deal rally.
We expect U.S. economic growth to slow somewhat in 2019 (compared to last year), mostly influenced by new risks from a global slowdown and trade disputes. We also anticipate that the Federal Reserve (Fed) will take appropriate steps to mitigate U.S. economic risks. We believe that investors should retain exposure to equities and fixed-income assets in alignment with their strategic objectives. If market volatility rises in coming weeks due to congressional inaction, that may present a compelling opportunity to rebalance and to capitalize upon any price dislocations.