Republic Pushback on Debt Ceiling Agreement Could Lead to Market Volatility

Financial markets could be volatile on Tuesday as a result of the tentative debt ceiling deal reached by President Biden and Kevin McCarthy because the deal faces a potential Republican rebellion in the House.

Andrew Clyde and Chip Roy are two Republicans pushing back against the deal citing $4 trillion in additional debt with “none of the key fiscally responsible policies passed”. Republican Ken Buck said he was “appalled” by a debt ceiling “surrender” and an estimated $35 trillion in U.S. debt by 2025.

It is impossible to say for sure how the market will respond on Tuesday. A debt ceiling agreement could lead to a big rally in U.S. stock markets after “massive” outflows during the negotiations. Reuters reported that in the week ended May 10, U.S. equity funds suffered outflows worth $5.7 billion, marking a seventh consecutive week of outflows. In the week to May 24, global money market funds received around $17.6 billion worth of inflows, the largest in three weeks as investors fleed to overseas markets. Credit rating agencies put the U.S. on “watch” for a potential downgrade ahead of the weekend.

The tentative agreement to raise the $3.14 trillion debt ceiling for two years would mean that further negotiations would not arise until after the 2024 election. Under the terms of the agreement, nonmilitary spending would remain flat in fiscal 2024 and rise by 1% in 2025. McCarthy said the deal would be “transformational” and would make the country stronger. Biden acknowledged, “The agreement represents a compromise, which means not everyone gets what they want.”

Treasury Secretary Janet Yellen warned that the failure to reach a deal could lead to “economic chaos” with the government unable to pay its bills as early as June 5.

Maya MacGuineas, President of the Committee for a Responsible Federal Budget, said, “We cannot default. It would be beyond stupid. We could create a recession here. We could create a recession around the world.”

ING Bank’s Carsten Brzeski said a default was the “mother of all crises,” but he also said that the U.S. could avoid a technical default for a few weeks by paying bondholders at the expense of other budgetary items, such as social security benefits and healthcare. The S&P 500 staged a 1.45% rally on Friday, and if a deal passes, it could lead to a strong week of gains as spooked investors rush back to the U.S. market.