(Bloomberg) — The government spending cap in the U.S. government deal to raise the federal debt ceiling creates new headwinds for an economy already plagued by the highest interest rates in decades and declining access to credit. giving.
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The interim deal negotiated by President Joe Biden and Speaker of the House Kevin McCarthy over the weekend (assuming it is passed by Congress in the coming days) would avoid a worst-case scenario in which non-payment causes financial collapse. is. But it could also increase the risk of recession in the world’s largest economy, even if only slightly.
Federal spending in recent quarters has supported U.S. growth in the face of headwinds such as weak housing construction, but the debt-restriction deal is likely to at least dampen that momentum. Two weeks before the debt-straightening deal, economists had estimated a 65% chance of a recession next year, according to a Bloomberg survey.
For Fed policymakers, the spending cap is another consideration as they update their own projections for growth and benchmark interest rates due to be released on June 14th. Futures traders were pricing in no change late last week. Rates will be raised at the mid-June policy meeting, with the final 25 basis points hike to be seen in July.
“At the same time that monetary policy is restrictive, fiscal policy will also be slightly restrictive and likely to become even more restrictive,” said Diane Swonk, chief economist at KPMG LLP. “We are pushing both policies in opposite directions and amplifying each other.”
The spending limits are set to go into effect in the fiscal year beginning Oct. 1, but by then they could have small effects, such as a backlash from COVID-19 aid or the impact of the phasing out of student loan forgiveness. But they are unlikely to show up in GDP calculations.
Tobin Marcus, Senior U.S. Policy and Political Strategist at Evercore ISI, also assesses how much spending limits are “merely a gimmick” as negotiators seek to bridge disagreements through accounting politics advised that it would be important
Still, next fiscal year’s spending is expected to remain subdued to around 2023 levels, and the restraints imposed by the deal will come into play at a time when the economy is likely to contract. Economists previously surveyed by Bloomberg had expected GDP to fall by 0.5% annually in the third and fourth quarters.
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“Fiscal multipliers tend to be higher during recessions, so if we were to go into a recession, cuts in fiscal spending would have an even bigger impact on GDP and employment,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. It’s possible,” he said. Email responses to questions.
Still, Ferroli’s latest thinking sticks to JPMorgan’s baseline scenario of the US avoiding a recession.
The U.S. economy has so far proven resilient despite the Fed raising interest rates by about 5 percentage points since last March, the centerpiece of the most aggressive monetary tightening campaign since the early 1980s. there is
The unemployment rate is at 3.4%, the lowest in more than half a century, thanks to a historically high demand for labor. Consumers still have surplus savings from the pandemic, according to a study by the San Francisco Fed.
Aside from the impact of the deal on the economic outlook, Fed officials will have a range of considerations as it will have some impact on money markets and liquidity.
The Treasury has been dwindling its cash balance to keep making payments since it hit the $31.4 trillion debt ceiling in January, and it plans to increase its reserves even further if the next bill suspends the ceiling. It plans to increase sales of short-term securities. normal level.
A wave of newly issued treasury bills would effectively drain liquidity from the financial system, but its exact impact can be difficult to assess. Treasury authorities may also arrange issuance to minimize disruption.
Economists will be watching closely in the coming weeks and months as the Fed cuts liquidity on its own by depleting its bond portfolio of up to $95 billion each month.
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Longer term, the extent of the fiscal restraints enacted by negotiators is almost certain to have little impact on the trajectory of the federal debt.
The International Monetary Fund said last week, “To put public debt on a decisive downward path by the end of this decade, the United States will need to tighten its basic budget, which excludes debt interest payments, by about 5 percentage points of GDP. there is,” he said. ”
Maintaining spending at 2023 levels would fall far short of such drastic restraints.
Evercore ISI’s Marcus said in a note to customers on Sunday that “the two-year spending cap at the core of the contract is a bit disturbing in the eyes of the beholder.” “Expenditure levels will remain broadly flat, fiscal headwinds to the economy will be minimal, while the deficit will be reduced only modestly,” he said.
–With contributions from Josh Winggrove, Jennifer Jacobs, and Erik Wasson.
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