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Raising the roof - A bilateral agreement on the national debt ceiling is likely to focus on restraining spending in the face of growing fiscal deficits.

Treasury Secretary Janet Yellen says the U.S. government may run out of money as soon as June 1, reinforcing a sense of urgency for the U.S. administration to tackle the challenge of reaching the national debt ceiling.

The drama around the U.S.

Cash reserves at the Treasury stood at a dangerously low level of about $86 billion in mid-April, but have since recovered to more than $200 billion.

We still expect congressional Republicans and the White House to reach an agreement (even a temporary one), but a contingency due to a tight legislative schedule is not out of the question.

Neither Republicans nor the White House want to be blamed for creating the default.

At the very least, both sides are likely to agree to a suspension of the national debt ceiling in the near term if a comprehensive agreement cannot be reached by June 1.

The new deadline could be pushed back to the end of July or the end of September through the end of the fiscal year, when an agreement on spending levels for 2024 would be needed.

However, there is a risk that the federal government could have trouble paying off its debt by June 1 if cash resources are exhausted much faster than expected in the next two weeks due to a tight legislative schedule.

The House of Representatives plans a vacation this week and again starting May 26, while the Senate is on vacation for the week of May 22 and returns on May 29.

The probability of miscalculation is therefore far from zero.

This is why the market now anticipates a much higher probability of default this time, as the cost of a one-year credit default swap (the cost of default insurance) is skyrocketing.

The main problem with the drama surrounding the debt ceiling is that rising expenditures have led to an increase in the federal deficit since the end of last year.

In March, the accumulated Treasury deficit (revenues minus expenditures) for the first three months of 2023 reached -$679 billion, which is significantly worse than in previous years (except for the pandemic years of 2020 and 2021).

In recent months, federal government revenues have remained almost at the same level, while expenditures have been increasing.

We warned about the growing fiscal deficits in 2023, although the pace of deterioration turned out to be worse than expected.

The share of expenditures relative to GDP currently stands at about 25%, which is 3 percentage points higher than before the pandemic, while the share of revenues relative to GDP has increased by only 2 percentage points.

The increase in government spending is a direct result of high inflation and high interest rates.

The first led to a sharp increase in social spending to compensate for rising prices.

For example, social security expenses increased by more than 9% in January.

The second factor led to a sharp increase in interest payments, as the average maturity of the U.S. federal debt is only five years (shorter than that of most European countries).

In March 2023, interest payments amounted to $565 billion (for the 12-month period), compared to $394 billion in March 2022.

On the other hand, the Federal Reserve's cessation of transfers to the Treasury—since the Monetary Committee is currently incurring (huge) losses—deprives the federal government of the equivalent of 0.5% of GDP annually.

Any kind of agreement is likely to include some forms of spending restrictions, although the White House is currently refusing to sign any proposals from the Republicans.

The Republicans passed their own bill last week ("Limit, Save, Grow Act"), which proposes significant cuts to domestic programs while maintaining the Pentagon's budget.

It is proposed to restore funding for federal agencies to the 2022 level while simultaneously limiting the growth of expenditures to +1% per year (which means a real reduction).

Republicans are also proposing to block President Biden's plan for student loan forgiveness, eliminate tax credits for green energy, and cancel new funding for the Internal Revenue Service (IRS) that was enacted under the Inflation Reduction Act (IRA) last year.

Although the current Republican bill has little chance of being signed by the White House, we expect President Biden to eventually agree to some spending restrictions - if not in June, due to a busy schedule, then by October 1, when the 2024 fiscal year begins.

Restrictions on spending for social security and health insurance will be difficult to avoid, as these programs make up the foundation of federal expenditures, although Republicans may soften their demands by October due to the weakening economy.

Grants to U.S. states, which have significantly increased since the beginning of the pandemic, may also be reduced.

On the other hand, Republicans may agree to some measures to increase revenue, despite their fierce opposition to tax hikes.

In any case, the fiscal policy of the United States is set to become restrictive from the end of 2023 and throughout 2024.

This will increase pressure on the economy at a time when tight monetary policy is hitting GDP the hardest (i.e., between mid-2023 and early 2024).