While an agreement on suspending the debt ceiling seems likely to make it through Congress, investors may want to monitor bank deposits for lingering risks.
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Welcome to the Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the U.S. debt ceiling and its impact on markets. It's Wednesday, May 31st at 9 a.m. in New York.
Today should bring a key step forward in resolving the debt ceiling dispute in Washington, D.C.. After the White House and Republican leadership reached an agreement over the weekend to pair a debt ceiling increase with a fiscal plan that caps spending growth for a time, the legislative plan advances to a vote in the House today. That vote is expected to succeed, with the only question being by how big a majority. After that, the deal moves to the Senate, which will likely have to work the weekend to enact the legislation before the June 5th X-date.
So it seems then that we're closer to taking a key negative catalyst off the table for markets and the economy. As you might recall from our prior podcasts, without a debt ceiling resolution before the X-date, the White House may have had to choose from some less than ideal options to avoid default. For example, they could have prioritized payments to bondholders over other governmental obligations, but that could have interrupted up to 18% of personal income in the U.S., creating substantial economic risk.
Further, the fiscal deal that enabled this raise of the debt ceiling doesn't appear to contain substantial enough spending cuts in the short term to hamper the economy. The Congressional Budget Office says it will cut deficits by about $70 billion in the first year, a very small number in the context of a roughly 26 and a half trillion dollar U.S. economy.
But there's one lingering risk worth monitoring. When the debt ceiling is raised, Treasury will start issuing Treasury bills to rebuild the balance in its general account so it can pay its obligations. That action could reduce deposits in the banking system, to the extent that they are bought by investors that aren't money market funds. We can't say that this would definitively be a negative catalyst for, say, midcap banks which have been dealing with deposit outflows, but it's a risk market participants will have to continue to monitor.
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