Debt-ceiling deal reached, vote to come

Executive summary:

• Democratic and Republican party leaders reached an agreement to extend the debt ceiling until 1 January 2025.
• Members of the House of Representatives and Senate will likely vote on the deal in the coming days. We believe it’s much more likely than not that the debt-ceiling legislation will be passed by Congress
• The deal likely represents a crisis averted, but until the votes are tabulated, it still warrants careful monitoring.

Over the weekend, the Biden White House and Republican House leaders reached a debt-ceiling deal, with text of the bill released on 28 May. The agreement extends the debt ceiling to $31.4 trillion until 1 January 2025. It also keeps overall government spending flat in 2024 and raises it 2% in 2025. In addition to these headline numbers, the agreement also expands work requirements for older Americans who receive government assistance. It also contains provisions to modestly increase military expenditures – to $866 billion in 2024 and $895 billion in 2025.

How are both parties reacting to the deal?

On the surface, the deal has spurred criticism from hardliners on both sides of the aisle. Republican hardliners are reacting to the fact that actual spending cuts were not achieved, and are also expressing disappointment that the work requirements are not more stringent. On the left, unsurprisingly, hardliners have criticised the work requirements that have been agreed to, feeling that the administration gave up more than needed to achieve a deal.

In terms of political reality, the opposition on the right is the much more complicating factor. Biden is the president and that comes with great influence and power, not the least of which is that he is elected by the people and not Congress. With this, Biden almost certainly can deliver enough Democratic votes to pass the bill. Dissatisfied Democratic representatives cannot threaten to remove him from office for striking a “bad deal.” House Speaker Kevin McCarthy is not so lucky, as the deal he struck to win the speakership leaves him vulnerable to any individual representative being so dissatisfied that they can ask for his removal. 

Will Congress ratify the deal?

In the days to come, the political dynamic will be important to watch as this process plays out. In the end, we believe that it is much more likely than not that the debt-ceiling legislation will be passed by the U.S. Congress. This is because political reality suggests that the majority of U.S. voters want a debt deal to be approved – and would have supported an increase in the debt ceiling with absolutely no concessions on the Biden administration’s part.

Now that the leadership has struck a deal, failure to pass this legislation due to the internal political process within the Republican party would likely result in Republicans being blamed for the repercussions.Those repercussions would likely be severe – so severe that failure in the year preceding a presidential election would make not passing a deal far too risky. With all that said, we believe passage of the deal is likely, but that the ultimate question might be: will Speaker McCarthy survive the process?

How would passage of the deal impact the U.S. economy?

In the end, if the deal is passed in the form described above, this should be a positive for the economy – and by extension, the Biden administration—in terms of taking the worst-case scenario of potential massive fiscal contraction and general uncertainty off the table. Either scenario would have posed a significant recession risk to an economy that already has a 55% probability of recession, in our view.  I suspect that this is ultimately what motivated Biden to give the so-called concessions that he did. 

While this deal likely represents a crisis averted, we are talking politics here and one never knows. We will monitor this process closely and let you know if this view changes. If the bill passes as is, it really won’t change our view on the fundamentals of the U.S. economy over the next two years. Our recession probability over the next 12-18 months remains at 55%.