Biden, McCarthy forge debt deal in bid to avert US default

White House and Republican negotiators reached a tentative deal late Saturday to raise the US debt ceiling and avert a default that threatened to send tremors through the global economy. 

President Joe Biden and House Speaker Kevin McCarthy, who sealed the agreement during a 90-minute phone call, must now shepherd the framework to final legislative passage over the objections of hardliners in both parties. 

McCarthy said he will talk with Biden again on Sunday and line the bill up for a vote on Wednesday. 

"We still have a lot of work to do, but I believe this is an agreement in principle that is worthy of the American people," McCarthy told reporters at the Capitol.

There's little margin for error, with Treasury Secretary Janet Yellen warning that an extension must be finalised by 5 June to avoid a historic default that would send borrowing costs soaring.

The deal – reached after weeks of bitter discussions – includes a two-year appropriations agreement that keeps non-defence spending roughly flat with current levels, a person familiar with the deal said, speaking on condition of anonymity.

It also suspends the debt limit through January 2025 – after the next presidential election. Some people familiar with the framework said that it would kick back in on 1 January, while another said the precise date may depend on the text of the bill, which was still being hashed out.

Either way, it sets up a scenario in 2025 similar to this year, when the Treasury Department began employing extraordinary measures in January to avert a default.

Economists have said even a short default could prompt the loss of hundreds of thousands of jobs. On 24 May, Fitch Ratings placed the US's AAA credit rating on watch in a move that reflected mounting concerns the US would go over the brink.

Financial markets

The pact will likely help reduce recent tensions in financial markets where investors had been demanding higher yields on securities set to be repaid shortly.

Rates on instruments due in early June topped 7% at one stage. Credit-default swaps, derivatives that allow investors to insure against non-payment, also showed elevated concern, with prices peaking well above levels seen in a pervious debt limit debate in 2011.

Still, the attention of investors may swing to other risks. The Treasury will now likely seek to replenish its emaciated cash balance – which on Thursday fell below $39 billion to its lowest level since 2017. 

The resulting deluge of bill sales is likely to suck a significant amount of liquidity out of markets, adding pressure at a time when the Federal Reserve has been raising interest rates and shrinking its balance sheet.

More details

While the agreement doesn't create work requirements for Medicaid recipients, it places time limits on the food assistance program known as SNAP up to age 54, a measure that House Republicans pushed for. Those would be phased out by 2030, however. 

In addition, the deal creates a mechanism to force Congress to complete annual appropriations bills for 2024. It would impose a 1% cut across the board if the bills are not passed. This encourages Republicans who would forgo the defense increases in the caps deal to come to an agreement, decreasing the chances of a 1 October government shutdown.

Initial reaction from economists, without knowing all the details of the reported agreement, indicated little expectation the pullback on government spending would have an outsized impact on the overall economy. Michael Feroli, chief US economist at JPMorgan Chase, said in an email the reported deal wouldn't substantively change the outlook he issued last week as the White House and Republican lawmakers drew close to an agreement.

In a note to clients on 24 May, Feroli suggested a cap on non-defence federal spending through fiscal year 2024 would have a modest impact on growth and could be offset if the Fed responded with a slightly less aggressive approach in its quest to slow the economy and tame inflation with higher interest rates.

Political impact

Although the tense negotiations put the country on edge, the agreement could bolster both Biden and McCarthy politically, assuming it garners enough support on Capitol Hill.

For McCarthy, scepticism that he would be able to negotiate an agreement given his razor-thin advantage in the House has hung over the speakership he won in a 15-vote runoff early this year. McCarthy arranged for a call with fellow House Republicans Saturday evening in Washington. 

The compromise, however, could also provoke an attempt by a handful of conservative lawmakers to call a vote to oust him. 

The president, at the same time, sidesteps the biggest threat to the post-pandemic economic recovery as he seeks a second term. Yet meeting some GOP demands also risks alienating progressives he needs to propel his reelection campaign.

The deal would clawback funding for Internal Revenue Service agents and accelerate some energy project environmental reviews, according to a GOP summary. 

The summary said that domestic spending in 2024 would be cut to fiscal 2022 levels. The differing take from the White House view is likely due to accounting gimmicks.

In terms of Covid-19 funding, the White House protected money for next-generation vaccines, veterans medical care funding, housing voucher funding and Indian health service, according to a person familiar. 

"The agreement represents a compromise, which means not everyone gets what they want," Biden said in a statement. 

White House budget director Shalanda Young, senior adviser Steve Ricchetti, and legislative affairs director Louisa Terrell crafted the deal with Representatives Garret Graves, a Louisiana Republican, Patrick McHenry, a North Carolina Republican, and McCarthy's chief of staff, Dan Meyer.