US debt ceiling deal - impact on liquidity and growth

Over the weekend, the White House and House Republicans announced a debt ceiling deal¹  which is expected to be voted upon by Congress later this week.

Market reactions around Asia have been mixed, with the Nikkei 225 reaching a new high since 1990 while the Hang Seng fell to a new low for the year.  

If the debt deal is successfully approved, which I expect it to be, then this removes a key overhang to US and worldwide markets and could provide a temporary boost to sentiment. As always, policy uncertainty breeds market volatility.

Investors can breathe a sigh of relief that the US government is not going to default on its debt and that the agreed in principle deal appears to have less onerous spending caps and cuts than the debt deal back in 2011, and initial estimates show the agreed-to cuts to have less of an impact on growth than previously feared².

What the debt ceiling deal would mean for market liquidity and growth

Looking out over the next few months, I’m more focused on what the debt ceiling deal would mean for market liquidity and growth.

This much is true, a debt ceiling deal would open the door for the US Treasury to issue north of USD 600bn in new treasury bills over the next 7 months³  in order to replenish its empty coffers.

This could create a noticeable suction sound as liquidity gets drained from the market. In response, bond yields could go up as capital flows out of the economy.

The recent regional banking crisis coupled with the expected Treasury issuances are likely to tighten liquidity conditions.   

Outlook

In conclusion, I believe the announcement of a debt ceiling is likely to be cheered by markets in the near-term, though the deal places a bit of pressure on growth due to government spending cuts over the next  couple of years and the Treasury draining liquidity from the market.

On the flipside, I believe the silver lining could be that these pressures on growth are doing the job for the Fed as it tries to cool the economy and wrestle inflation back down towards its 2% targeted level.