Market Conversations: The U.S. debt ceiling debate

Brian Levitt:

Welcome. I'm Brian Levitt.

Jodi Phillips:

And I'm Jodi Phillips. We're talking about the debt ceiling today. Jen Flitton is here. Yes, I know. Favourite topic, right? So Jen is Invesco's Head of U.S. Government Affairs, and she's going to shed some light on the negotiations happening in DC and let us know where she thinks this is all heading. And since she's here, we'll also ask for her thoughts on the national political mood and how things might be shaping up for 2024. I know you always like to get a sneak peek into that, Brian.

Brian Levitt:

Feels too soon.

Jodi Phillips:

It feels a little too soon. But in any case, are you ready for another debt ceiling crisis?

Brian Levitt:

I'm ready for it. I feel like I may already be living it, although hopefully we're getting some slightly positive news here. Jodi, life is strange when you're constantly refreshing your screen to see how high the one-month U.S. Treasury yield is going. That's where I am in life right now.

Jodi Phillips:

No, I hear you. If you don't know if you'll be paid the income on it, makes sense to keep an eye on it. So, look, with that question Brian, what are you saying to investors who have that same question?

Brian Levitt:

I'm trying to be optimistic. Look, we've done this 86 times since John Kennedy was president. We usually do it without incident, usually a mere formality. And so I think we'll raise the debt ceiling. I keep coming back to that line about what Churchill was said to have said about Americans.

Jodi Phillips:

We always do the right thing, but only after exhausting all other options. I think I've heard you say that in a podcast or 10.

Brian Levitt:

Exactly. I probably need some new material here, but we keep-

Jodi Phillips:

No, stick with the classics.

Brian Levitt:

We keep repeating over and over, so I keep coming back to it. But another favourite of mine is that market volatility doesn't emerge out of nowhere, it's always the result of policy uncertainty. And so that's what we're looking at here, perhaps.

Jodi Phillips:

Well, we are, but it's a little ironic. Just when we get maybe some clarity or close to clarity on monetary policy, now we get uncertainty about fiscal policy.

Brian Levitt:

And hopefully short-lived. And the good news is we do have a historical parallel to consider. If you remember 2011, you had a very short-lived risk-off trade. And I still think it's ironic — Treasuries rallied. Something's going to potentially default, let's buy the thing that's going to potentially default. So Treasuries rallied and ultimately, it created a buying opportunity for investors in the early stages of a new cycle.

Jodi Phillips:

Very good. Well, on that note, let's bring in Jen to help explain what's going on in the here and now. Welcome, Jen.

Brian Levitt:

Hey, Jen.

Jennifer Flitton:

Hi guys.

Brian Levitt:

Hey Jen, why do we still do this when this is happening?

Jennifer Flitton:

Well, it depends if you're a Republican or a Democrat, what your answer would be to that.

Brian Levitt:

Well, I'm not allowed to answer that question. I'm everything to everyone.

Jodi Phillips:

What about both sides? Let's get both sides.

Jennifer Flitton:

You're right. From the Democratic perspective, they would love to push this off. In fact, some say if they had their way, if they were able to get rid of the filibuster or had the reconciliation process back, they would extend debt ceiling forever, get rid of this congressional authorization of debt ceiling raising. From the Republican perspective, we have a $31.4 trillion debt. So we're looking at austerity arguments from the right for a while now, and I think that this will be used consistently as leverage going forward.

Brian Levitt:

Jodi, I had read that if you take 31.4 trillion dollar bills and stack them, you would get to the planet Uranus.

Jodi Phillips:

Well, that's some trivia that you're not going to find on any other podcast. So Jen, let's talk about the calendar a little bit. Personally, I was surprised when Janet Yellen came out and said June 1st was looking like the X date. I thought with incoming tax receipts, the Treasury had extraordinary measures, I was under the impression that they could buy some time until the fall. So what's behind June 1st, and can we still extend that a little bit?

Jennifer Flitton:

Well, yes, and she did give a caveat when she said June 1st is the X date. She did hedge herself a bit stating that it could be a few weeks, a few days from June 1st. So the real magic number would be June 15th, because if they could get to June 15th, the quarterly tax receipts, then you could extend it probably till the end of July. But it's just not clear. She's going to make another announcement next week.

Brian Levitt:

But we were originally saying September, October, November, right?

Jennifer Flitton:

Well, we always said it could be as early as June. Treasury did warn us.

Brian Levitt:

Maybe I was saying September, October, November.

Jodi Phillips:

Maybe that's why I was so surprised, Brian. I know where I got that from.

Brian Levitt:

I just make it up and sound confident.

Jennifer Flitton:

And we saw on the horizon from some of the analysts, whether it was Goldman or JP, I can't remember, but they were saying some of the tax receipts coming in after April were looking like maybe cap gains were a little too low and that that could affect this X date, and it may have.

Brian Levitt:

What is an extraordinary measure?

Jennifer Flitton:

Basically, once the Treasury Secretary gets to a certain point, she has to extend into extraordinary measures. And because we spend a lot more than we bring in, that usually is in the first quarter of the year where we start to acknowledge the fact that tax receipts and payments aren't going to match up.

Brian Levitt:

And so what does that mean? We're not going to invest money in government pension funds? Are there things that we do that let us push this out a little bit?

Jennifer Flitton:

It's a little gimmickry in the way that Treasury accounts for things, without getting too technical, that allows for them to extend their budget.

Brian Levitt:

And so what do the Republicans want? I obviously used the word austerity, and I remember in 2011 when we went to the brink, correct me if I'm wrong, the Obama administration ultimately conceded to $2- to $3 trillion in spending cuts over a decade. Seemed like some pretty large numbers. Are we talking something similar here?

Jennifer Flitton:

Well, where the Republican stand is on the bill that they were able to pass last month, which was April. And now Democrats are coming to the table and coming up with a different negotiating position. That's what we're seeing. But included in that original House bill, I think it was a cap to 2022 spending and it extended only a 1% increase in discretionary spending until 2033. So that's a 10-year move. That's not going to be acceptable to the White House. So reports are they're coming back with a 2023 cap, but only for two years. I think they'll probably land somewhere in the middle, but closer to the White House's position. But you're right, this is very similar to 2011, and that's what brought on the sequester. And that really comes out through the appropriations process. Because it's a promise into appropriations, how they're going to spend the framework.

Jodi Phillips:

Sequester. That word takes me back a little bit.

Brian Levitt:

Remind me of the sequester. What did that mean?

Jennifer Flitton:

It was a little bit of budget gimmickry, because what ended up happening was a promise of decreased spending, and then the constituencies of federal government spending came in around the appropriations process and they were able to kick some of that sequestration down and basically out of actually happening through the appropriations process. So this is the easy part. You're just setting a framework with these budget caps. Actually doing that comes later, during the appropriations process.

Brian Levitt:

I have a really dumb question, Jodi.

Jodi Phillips:

Go for it.

Brian Levitt:

So let a little bit more than 10 years ago, so this was Obama in 2011, they agreed to the spending cuts over a decade, and yet we just saw $6 trillion of spending in 2020 and 2022 for COVID. So most of that's within the 10-year period. So did we accomplish anything the last time we did this?

Jennifer Flitton:

Well some of the sequestration happened, but a lot of it that was difficult to do didn't happen because there were... Especially when it came to some physician payments, and I was on the Hill at the time, I remember just the health care community coming down and being really concerned with some of the cuts and how that would affect patients and hospitals, et cetera. So some of it happened, some of it didn't. I think what you're looking at with the COVID payments, that was outside of the ordinary budget. It was emergency appropriation money. And so a lot of that is still sitting at Treasury. It's sitting in the coffers of the states. But a lot of it's still sitting at Treasury and that's why it's on the table for this negotiation.

Jodi Phillips:

So looking at the math and the makeup of Congress right now, how many Republicans would need to break party line to raise the debt ceiling? What does that look like? How does that shake out for getting this done?

Jennifer Flitton:

So McCarthy needs a majority of the majority. So he needs at least 120 members, somewhere around there, to vote for whatever he negotiates with the White House. So keep in mind, this last meeting that was announced on Wednesday, or was it Tuesday when they met. They decided that it would just be McCarthy and his team. So Garrett Graves, who is McCarthy's right hand man. McCarthy's team and the Biden team. So Steve Richetti, who has been a longtime advisor, and Shalanda Young, who is the OMB Director, the Office of Management and Budget, and she used to be the staff director of appropriations. She's well liked, she's well respected on both sides of the aisle. So now with these brains in at the table and only them... Because before it was too big, there were too many people at the table. They've really narrowed it down. And so they're negotiating right now and McCarthy is socializing it with a few folks and getting his top people, his top members of Congress, together. They had a table session yesterday to get ready to socialize to a larger segment of the conference.

Brian Levitt:

Jen, what I think in some ways Jodi was getting at there is the last time we did this in 2011, the Democrats had just gotten shellacked in the midterms and I purposely use the word shellac. That was Barack Obama's word, that was not my personal word. Now this time, there was an expectation of a red wave that didn't materialize to the extent that some expected it to. So can I have any confidence in the fact that the Democrats had to figure out how to get 50 or 60 Republicans on board for this in 2011, versus today they need to get five or six. Can that make me more hopeful or is that just being too Pollyanna?

Jennifer Flitton:

Well, I think Democrats, you mean in the House?

Brian Levitt:

Yeah.

Jennifer Flitton:

Hakeem Jeffries, who is the minority leader, the leader of the Democratic Party, he's going to have to bring a number of folks to the table, for the voting actually.

Brian Levitt:

So it's going to be hard to get all of his because of the cuts that are being made. So if Biden plays hardball and they can get all of the Dems, are there five Republicans or no?

Jennifer Flitton:

Oh no, you mean in a discharge petition. Because they have a discharge petition that they put out. But you don't have five or six Republicans who are going to undercut…

Brian Levitt:

They're not going to do it.

Jennifer Flitton:

... right now. No, that's not going to happen.

Brian Levitt:

So even though you needed 50 in 2011 and today you need five or six, it still doesn't matter.

Jennifer Flitton:

Yeah, no. It would be like voting for Hakeem Jeffries as speaker. You're just never going to get this vibe.

Brian Levitt:

It's the end of your political career if you do that.

Jennifer Flitton:

What's going to happen is McCarthy and Biden are going to come to some sort of agreement, and then McCarthy has to go back and sell it to his people. His very right are not going to vote for it. But can you shave off a few of them? Can you get a few of those Freedom Caucus members? And to give cover for others who are going to get hit from their right, that it's not enough. And then you have Jeffries who is going to have to make sure that his moderates and his establishment Democrats are voting for it as well, even though the progressives are going to rail against maybe some of the work requirements that might be included in it. And so they have to be concerned about each of their right and left for length.

Brian Levitt:

I'm singing Schoolhouse Rock in my head right now.

Jodi Phillips:

Just a bill.

Brian Levitt:

Just a bill.

Jodi Phillips:

So what about other methods of getting around this? There's a lot of talk about the 14th amendment, the validity of the public debt shall not be questioned. Does that give cover to just forget about the debt ceiling?

Jennifer Flitton:

Yeah, it would be a constitutional crisis. And so you've seen Secretary Treasury Yellen, pretty much outright rejected. Now, I think there are others within the White House who may be a little more open minded to that or to minting a trillion dollar coin or something. But ultimately that would go into the court system, it would be litigated, and it could really be devastating as far as the process.

Jodi Phillips:

Brian, the trillion dollar coin, I know that was your preferred method of fixing this, right?

Brian Levitt:

Yeah, I was very excited about that. We mint a coin and we make it available to ourselves. Oh yeah. Well, it doesn't sound like we're going to be minting that trillion dollar coin. So Jen, we don't mint the coin, unfortunately. What would it look like if we breach it? I know Jodi and I had joked up front about the one-month T-Bill. People don't want to invest there because they don't know if they're going to be generating any income in that particular month. Is it just the thing, if you own it, you're going to get paid back at some point, you just may have lost income? What does it mean to default on this?

Jennifer Flitton:

And what is a technical default and how can Treasury prioritize payments in order to pay the debt first? And I think that's really the larger question.

Brian Levitt:

Can we do that? Shut down a national park and keep paying the debt?

Jennifer Flitton:

I don't think we're going to save too much there, but we could potentially.

Brian Levitt:

Don't pay the prosecutors? What are we doing?

Jennifer Flitton:

Think of infrastructure or military infrastructure where 13% of our budget goes. Defense projects, et cetera.

Brian Levitt:

So it's not rangers at the park.

Jennifer Flitton:

That's not really our money maker. That could happen in some sort of prioritization. So you get the Social Security checks, you get the veterans checks, and you get the debt paid for. And really think about it this way, say June 1st is the true X date. You have two weeks you really need to account for in the prioritization. Now, what would actually happen to the credit rating in the United States if we get past the X date? That's a much larger question. What do the markets do? But technically, we know the New York Fed's been running tabletop exercises on this sort of thing happening for the last decade. So there is a way to buy time, at least it's been suggested in reports, that there is a way to write buy time through prioritization.

Brian Levitt:

And thus far, the markets have been pretty sanguine about this, at least it seems

Jennifer Flitton:

It seems, right?

Brian Levitt:

It seems. We haven't had a big drawdown, little range bound on broader markets, S&P 500 type of thing, but nothing extreme. So the most likely outcome, Jen, you still believe that we get past this without significant incident?

Jennifer Flitton:

I think we either go right up to the X date with some deal, or maybe just go a little bit past it. And I think the framework of the deal is going to be budget caps of some sort. It's going to be COVID funding rescissions, it's going to be energy permitting reform, and some degree of work requirements around TANF, definitely not Medicaid, possibly around food stamps, the SNAP program.

Jodi Phillips:

So Jen, while we have you here, let's talk about legislation. Are there any big topics that investors in particular need to be focused on?

Jennifer Flitton:

Well, again, going back to this legislation, this is probably one of the biggest that we're going to see happen. And then the next big move will have to be appropriations. Then we can get back on this podcast and talk about a potential government shutdown.

Brian Levitt:

Wait, will the national parks be open?

Jennifer Flitton:

Now that actually might close the national parks. But so that you give some runway then to the appropriations process can really begin, because they've had a hard time doing budget resolutions on either side of either chamber because this looming debt ceiling is so large and it's just sucked all the oxygen out of the room and taken a lot of the folks who are needing to draft on appropriations into this negotiation.

Brian Levitt:

So Jen, we're going to ask about 2024. I'm not even ready to start thinking or talking about 2024, but the people want to know what you're thinking. Are we running it back again? The fans want to know, are we running it back again? Is it Biden v. Trump? Who's going to win?

Jennifer Flitton:

Right now, Biden has said he is running and he's the president of the United States, and Bobby Kennedy Jr. is what? Running at 20%. Although that is rather high in some-

Brian Levitt:

Is he at 20%?

Jennifer Flitton:

He's 19%, 20% on some polls.

Brian Levitt:

Wow. Talk about name recognition, huh?

Jennifer Flitton:

Well look, President Biden obviously has some issues in his favourability, and the fact that Kennedy is running against him, and I think Marianne Williamson threw her hat back in the ring too, although I don't think she's polling. That's going to cause a bit of a headache for the Democrats, because that's a little too high in the polling. And we'll see if that's adjusted as we get closer to the general. But in the primary for Republicans, you have a lot of folks throwing in their ring.

There are going to be a number of people around the Memorial Day period that are going to formalize their run, like Tim Scott's expected to announce, for example, on the 22nd on Monday in Charleston. He just launched his exploratory committee. Some of these guys have just launched exploratory committees and are now going to officially get in the race. But of those currently in the race, you have Nikki Haley and Asa Hutchinson, and DeSantis has not announced yet, but he will. And it's going to be a very wide field. You're going to start to see the debates then around the August, September period for Republicans, and that's really going to feel like the kickoff for the American people who aren't paying attention quite yet.

Brian Levitt:

The big stage with a lot of podiums again.

Jennifer Flitton:

Exactly.

Brian Levitt:

And that probably favours the former president?

Jennifer Flitton:

I think the more Republicans in the primary, the better for former President Trump. How many stay in, I think is the larger question.

Brian Levitt:

And does it feel like a change election, 2024, or too soon to say?

Jennifer Flitton:

Too soon to say. I think we have to allow the process to play out a little bit to see where these numbers start to fall.

Brian Levitt:

And you had made an interesting point about where Hillary Clinton was polling in the 2008 primary before, just to put a finer point on how early it is.

Jennifer Flitton:

That young first-term-

Brian Levitt:

Junior senator.

Jennifer Flitton:

... Democratic junior senator from Illinois, Barack Obama, had the gall to go up against Senator Hillary Clinton. And she was polling much higher than he was. And I think that's why you have to take some of this and step back and realize that we're going to have... Americans really just aren't paying attention yet.

Jodi Phillips:

All right. Well, what I'm getting, the is let the process run its course, whether it's the debt ceiling or elections. So Brian, are you feeling any better than you were at the top of the show about that process?

Brian Levitt:

Yeah, I feel good. Yes, I'm one of those people who believes in the Churchill line. Ultimately, we will do the right thing, we will get past this, and we'll be back to focusing on what's most important for investors, which is where are we with regards to monetary policy? Is a new cycle starting to play out? And I'm looking forward to getting back to that focus, but I'm thrilled that we were able to have Jen here as we're dealing with these current challenges.

Jodi Phillips:

Yes, thank you for joining us, and hopefully we won't have to have you back to talk about a shutdown, but would love to talk about anything else that's going on. So thank you.

Jennifer Flitton:

Thanks.

Brian Levitt:

Bye Jen. Thank you.

 

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Important information

Recorded date: May 18, 2022

Some references are U.S. centric and may not apply to Canada.

All figures are in U.S. dollars.

The opinions expressed are those of the speakers, are based on current market conditions as of May 18, 2023, and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. Invesco is not affiliated with any of the companies or individuals mentioned herein.

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Number of debt ceiling increases from the U.S. Treasury as of December 31, 2022.

Information about Treasuries rallying in 2011 is from Bloomberg. U.S. Treasuries rose 6.7% from July 2011 to September 2011.

All data provided by Invesco unless otherwise noted.

TANF stands for Temporary Assistance for Needy Families.

SNAP stands for Supplemental Nutrition Assistance Program.