Biden pact puts brakes on US economy

Biden (right) and McCarthy have found the middle ground. — Reuters

WASHINGTON: The cap on government spending in Washington’s deal to raise the federal debt limit adds a fresh headwind to a US economy already burdened by the highest interest rates in decades and reduced access to credit.

The tentative deal crafted by President Joe Biden and House Speaker Kevin McCarthy over the weekend, assuming it’s passed by Congress in the coming days, avoids the worst-case scenario of a payment default triggering a financial collapse.

But it also could, even if at the margin, add to the risks of a downturn in the world’s largest economy.

Federal spending in recent quarters has helped support US growth in the face of headwinds, including a slump in residential construction, and the debt-limit deal is likely to at least dampen that impetus.

Two weeks before the debt-limit deal, economists had calculated the chance of a recession in the coming year at 65%, a Bloomberg survey showed.

For Federal Reserve (Fed) policymakers, the spending cap is a fresh consideration to account for as they update their own projections for growth and the benchmark interest rate, which are due for release on June 14.

Futures traders as of late last week were pricing in no change in rates for the mid-June policy meeting, with one final 25 basis-point hike seen in July.

“This will make financial policy slightly more restrictive at the same time that monetary policy is restrictive and likely to get more so,” said Diane Swonk, chief economist at KPMG LLP.

“We have both policies moving in reverse and amplifying each other.”

The spending limits are expected to be applied starting with the financial year beginning Oct 1, though it’s possible small effects will emerge before then, such as through clawbacks of Covid assistance or the impact of phasing out forbearance towards student debt.

Those would be unlikely to show up in gross domestic product (GDP) accounts, however.

Tobin Marcus, Evercore ISI’s senior US policy and political strategist, also advised that it will be important to assess the degree to which spending limits are “pure gimmickry” as negotiators seek to bridge differences via accounting manoeuvres.

Even so, with spending for the coming financial year expected to be held around 2023 levels, whatever restraint the deal does impose would kick in at a moment when the economy might be in contraction.

Economists surveyed by Bloomberg previously pencilled in a 0.5% annualised drop in gross domestic product for both the third and fourth quarters.

“Financial multipliers tend to be higher in a recession, so if we were to enter a downturn, then the reduced financial spending could have a larger impact on GDP and employment,” Michael Feroli, chief US economist at JPMorgan Chase and Co, said.

Still, Feroli’s latest thinking sticks with JPMorgan’s base case of the United States avoiding a recession.

Despite some five percentage points of Fed rate hikes since March of last year, the centrepiece of the most aggressive monetary-tightening campaign since the early 1980s, the US economy has so far proved resilient.

Unemployment is at its lowest in more than a half-century, at 3.4%, thanks to historically high demand for workers. Consumers still have excess savings to use from the pandemic, a San Francisco Fed study showed.

Fed officials will have a range of considerations because, aside from the deal’s impact on the economic outlook, it will have some implications for money markets and liquidity.

The treasury has run down its cash balance to keep making payments since it hit the US$31.4 trillion (RM144 trillion) debt limit in January, and once the ceiling is suspended by the coming legislation, it will ramp up sales of treasury bills in order to rebuild that stockpile to more normal levels. — Bloomberg

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