US debt ceiling is dangerously close, warns analyst Charles Myers
It was a week in which anything seemed possible in politics. The spectrum of plausible futures covers an unprecedented default on federal debt, at one extreme, and, on the other, the adoption of several trillion-dollar tax packages that would reshape the social contract. It’s a lot to take.
To put chaos in context, Barron called Charles Myers, a trendy political analyst and chairman of Signum Global Advisors. In an interview in March, he warned that virtually all Democratic priorities other than taxes and infrastructure would be dead upon arrival in a divided Senate, and the country would soon face another debt ceiling crisis. Here we are. He updated those projections in a phone conversation on Friday afternoon, as he had just finished meetings on Capitol Hill. This transcript has been condensed and edited for clarity.
Barron: Let’s level-set. How dysfunctional is the political process currently on a scale of 1 to 10? One is, let’s say, we’re going to exceed the debt ceiling, and the 10th is that things are working out well.
Charles Myers: It varies depending on the problem. On BIF [the bipartisan infrastructure framework] and on reconciliation, I would say that the dysfunction is much less than it seems from outside, that is to say inside the Democratic Party. We might even have a vote on BIF tonight. He can slide until tomorrow. They are very close. On this point, I would give it an eight, despite the noise.
On the debt ceiling, I would give it two because the Democratic leadership insists that Republicans vote with them to raise or suspend the ceiling. It just won’t happen. Their procedural alternative to raising the ceiling is to pass a new budget resolution, only Democrats, and then hold a stand-alone vote on the debt ceiling and raise it to a new number. From everything we’ve seen, this process could take anywhere from seven to ten days. If they really accelerated, they might be able to do it in three or four days, but that assumes that everything is working perfectly. Nothing in Washington ever works perfectly.
The risk on the debt ceiling is that we are getting much closer to the edge than is comfortable for the markets. If there is no clarity on how to resolve the debt ceiling, I would say before October 8, 9, 10 the markets will start to really sell. The risk of missteps and exceeding the ceiling is then quite high.
On this issue, the level of dysfunction is quite high due to the politics involved and the anger of Democrats for voting bipartisanly three times under President Trump to raise or suspend the cap.
What would tip the Democrats in starting the reconciliation process to raise the debt ceiling? Because like you said, right now they’re angry that the Republicans don’t want to help them.
It’s going to be a function of two things. First, if the BIF is indeed passed in the House, it does and is a great victory for Biden and for the Democrats. The second thing is the timing, which is the reality. As we head into the next four to five days, leaders really come up against a calendar deadline, which could in fact – and they are well aware of it – put them in very dangerous waters.
It seems that even in the best of circumstances, we predict that much of October will be filled with alarming headlines from Washington.
On the debt ceiling, yes. For the market, this is the biggest problem right now in the very short term. Our base scenario is that the Democrats will raise it just in time, but we’re going to get a little closer to the edge than is comfortable for the market.
Let’s talk about the rest of the legislative package. You just returned from Washington. What did you hear?
A few takeaways: One is, between moderates and progressives, there is much more common ground on almost all of Biden’s national programs. [than press reports suggest]. The vast majority of Democrats really want this to happen. Raising the debt ceiling, they all know they have to. And then on the rest of the agenda, the reconciliation package, there is disagreement on the size. I think in the end [West Virginia Sen. Joe] Manchin can be moved, and we’re probably looking at between $ 1.5 billion and $ 2 trillion in new spending.
Progressives will not be happy with this number, but they will accept it. There will still be quite a bit of negotiation and disagreement over the content and size of each of the different programs. What is happening is that most of the expense categories would just be reduced, not necessarily on a pro rata basis. For example, the proposal to make the expanded child tax credit permanent will be replaced with a one-year extension, or something similar. It actually saves a lot of money. Expanding Medicare to include vision, dental and hearing, maybe it’s just to include, this time around, vision and dental care. Before universal kindergarten all of these things are probably funded, but they are reduced quite dramatically.
What about taxes?
There is an even larger consensus around tax increases. While Manchin is one of the main barometers of what can and cannot be done, he has in fact been quite explicit on taxation. He wants the corporate rate to rise to 25%. We think it can be moved on this. It might be 26% or 26.5%, but at the very least we know he is in favor of an increase to 25%. He is in favor of increasing the top marginal rate for households earning over $ 400,000 to 39.6%. We should just assume it’s a done deal.
Where there is generally tax disagreement, it is more around capital gains. But there is still a broad consensus. The Ways and Means Committee, with influence from the Senate and the White House, has really reduced the increase in its cap gains. To take a rate of 20% [where it stands after the Trump-era tax cuts] at 25% is a huge compromise, even at the start. Initially, Biden wanted to overtake him.
My main point is that when it comes to taxes, there is a much larger consensus than people realize. We should assume that most of these tax increases are going to happen.
Is the main driver of the agenda the electoral cycle, rather than an overarching political philosophy? You describe, for example, that the child tax credit is not permanent but that it is extended by one year. Is the motivation of the Democratic leadership simply to put a victory on the board, so they can go halfway through with something behind them?
It’s both. But if I had to choose which of the two – that is, an electoral strategy or, ultimately, designing and adopting policies to help millions of Americans – is the bigger driver, I would say that it is. is the electoral strategy. I know my Democratic friends won’t be happy if I say this, but we should call it that. To be fair, the design of these programs and the widening of the social safety net by such an extreme amount, the largest since the FDR, are very close.
The electoral strategy is to go for growth at any cost halfway through, and in the process, I also hope I have raised millions of American families and hope they will vote Democratic. I feel very confident in the first part, that is, they will bring the strongest recovery in modern history. Whether they can pick up, except for a very short time, millions of American families, and turn them into Democrats or bring them back to the Democratic Party, is an experience that we will see if it succeeds next year.
One last point. In this democratic strategy of growth at all costs, they are less concerned with collateral damage, including inflation, the deficit or the stock markets. We just need to be very clear about it.
Should investors be worried?
I think so, but in the short term it has been an extremely positive strategy for the markets. The markets continue to hit new highs, and although we have these downturns, they have bought opportunities. For our clients and for investors, inflation has already picked up.
At some point next year, we will reach an inflection point where very good news for the economy, especially overall GDP numbers and jobs numbers, will turn into very bad news for the markets. Because it means that at this point inflation is even higher, the economy is overheating and the Fed is going to step back and will need to tighten. We think the Fed is going to have to hike rates probably two to three times next year. I think this inflection point for the markets will likely occur at some point in the first or second quarter of next year.
Getting back to the debt ceiling, is there a way for Democrats, including the president, to be re-elected if there is a debt ceiling misstep or a total and long-standing violation? term?
It depends on the severity of the collateral damage to both the markets and the economy. In 2011, when we actually temporarily broke the cap and then got downgraded by S&P, the US equity markets sold 17% high to low during that time, which was very painful. People forget how painful it was. But that being said, it was only a matter of days. Congress then voted to raise the cap, and that was resolved again. If it is that scenario, then it is damaging but not catastrophic for Democrats at mid-term or in 2024. Obama was re-elected in 2012, a year later.
Now, if there is a worse case scenario than 2011 that is, we cross the ceiling because we are hitting all-time highs in just about every asset class including US equities , and there is so much leverage built into this market at every level, the worst-case risk movement this time around could be much faster and much, much deeper. In the worst case, yes, it could be very bad for Democrats. I don’t see that happening. It’s just playing the potential worst-case scenario.
Bad for Democrats, and obviously bad for everyone.