Fast-forward to Summer: Avoiding Default, a Very Close Call
Author: Greg Valliere
January 24, 2023
THE BOTTOM LINE: There has to be a deal — eventually — and we’re sticking with our 60-40 odds that there won’t be a default. But if there’s a 40% chance of default, that’s too close for comfort.
AS IN PAST DEBT CRISES, Treasury Department officials are unsure when an actual default may occur. They believe all options, such as draining government accounts, could avoid default until mid-summer, but we think it may be late summer.
THE SCENARIOS: What stands out on the timing is that neither party is in any rush to begin working on a deal. The White House, for now, refuses to negotiate; both parties are content to bash the other for irresponsibility. Joe Biden, badly wounded by the documents scandal, has lost political clout.
SO FIRST AND FOREMOST, there will be no quick breakthroughs in coming weeks or even months. An assertion by Mitch McConnell last week that the U.S. would never default was met with surprising criticism from Senate Republicans, who are in no rush; they first want to see what the House can produce.
BY SPRING, THE HOUSE WILL PRODUCE A BUDGET DOCUMENT that will contain steep spending cuts, probably reverting back to fiscal 2022 levels. That is totally unacceptable to Democrats, and will lead to a high-stakes battle this summer.
OUTSIDE PRESSURE: Much will depend on the markets; if there’s volatility and growing fear of a default, that could prompt the Republicans to cave. Wall Street officials will pressure Congress to act, as will Fed Chairman Jerome Powell. And there will be all sorts of gimmicks — such as creation of a $1 trillion coin — that will go nowhere.
NEGOTIATIONS WILL INTENSIFY by spring, but moderate Republicans — and even some Democrats like Joe Manchin — will insist on some spending restraint. The key issue will be defense spending, headed for a likely haircut. Pentagon outlays will not be close to this year’s 10% increase, and funding for Ukraine may decrease.
THE KEY TO MEANINGFUL DEFICIT REDUCTION is the entitlement programs — but there will be no major cuts for Social Security, at 23% of all federal outlays, Medicare at 14% and Medicaid at 12%. Other mandatory programs like veterans’ benefits account for another 14%.
ASTONISHINGLY, all non-defense discretionary spending only accounts for about 16% of federal outlays, yet voters think it dominates the budget. They are convinced, for example, that foreign aid accounts for 10% of federal outlays, but it’s less than 1%.
RATHER THAN SLOG THROUGH CUTS TO EVERY FEDERAL PROGRAM, the negotiators probably will take the relatively simple option of a spending freeze, with modest increases for defense and Ukraine.
ONE OBVIOUS SOURCE OF REVENUE would be a tax increase, but there’s absolutely no chance of that passing. We continue to anticipate a remarkably quiet tax climate until the Trump tax cut expiration has to be addressed in two years. A proposed Value Added Tax is going nowhere.
AS A MID-SUMMER DEADLINE APPROACHES, we think both parties will be talking (a budget deal endorsed by Kevin McCarthy could cost him his job). If there’s no deal and a U.S. default looks imminent, Powell could step in — with great reluctance — to buy bonds that are close to default.
IN THE FINAL ANALYSIS, we return to our mantra — who has the votes? Are there enough votes for a deal? Certainly not now. We still think there will be a deal, but it’s months away, as both sides posture ahead of serious negotiations..
The views expressed in this blog are provided as a general source of information based on information available as of the date of publication and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Speculation or stated believes about future events, such as market or economic conditions, company or security performance, or other projections represent the beliefs of the author and do not necessarily represent the view of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and AGF accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Any financial projections are based on the opinions of the author and should not be considered as a forecast. The forward looking statements and opinions may be affected by changing economic circumstances and are subject to a number of uncertainties that may cause actual results to differ materially from those contemplated in the forward looking statements. The information contained in this commentary is designed to provide you with general information related to the political and economic environment in the United States. It is not intended to be comprehensive investment advice applicable to the circumstances of the individual.
AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), AGF Investments America Inc. (AGFA), AGF Investments LLC (AGFUS) and AGF International Advisors Company Limited (AGFIA). AGFA and AGFUS are registered advisors in the U.S. AGFI is a registered as a portfolio manager across Canadian securities commissions. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. The subsidiaries that form AGF Investments manage a variety of mandates comprised of equity, fixed income and balanced assets.
About AGF Management Limited
Founded in 1957, AGF Management Limited (AGF) is an independent and globally diverse asset management firm. AGF brings a disciplined approach to delivering excellence in investment management through its fundamental, quantitative, alternative and high-net-worth businesses focused on providing an exceptional client experience. AGF’s suite of investment solutions extends globally to a wide range of clients, from financial advisors and individual investors to institutional investors including pension plans, corporate plans, sovereign wealth funds and endowments and foundations.
For further information, please visit AGF.com.
©2023 AGF Management Limited. All rights reserved.