Biden, McCarthy Meet on Debt Ceiling as Wall Street Starts to Worry

The Washington Post / Tony Romm, Rachel Siegel, Leigh Ann Caldwell

12:06 JST, May 23, 2023

WASHINGTON – With as few as 10 days remaining until the U.S. government could default, President Biden on Monday resumed direct negotiations with House Speaker Kevin McCarthy (R-Calif.), hoping to resolve a stalemate over the debt ceiling that has started to spook Wall Street.

The two men entered the new round of talks after a weekend of turbulence and acrimony, and mere hours after the Treasury Department issued its latest warning – this time, using more urgent language – that the U.S. is “highly likely” to run out of cash and other options in early June, perhaps as soon as the first of the month.

Opening the meeting, Biden told reporters they remain “optimistic we may be able to make some progress,” acknowledging that Democrats and Republicans have “got to get something to sell both sides and we need to cut spending.”

But he still alluded to the myriad disagreements between the parties over how, exactly, to meet those goals. The president said he aims to explore “tax loopholes” and tax increases targeting wealthy Americans, which McCarthy and his fellow Republicans long have rejected. The House speaker, for his part, added they “both agree that we need to change the trajectory, that our debt is too large.”

Unless Congress raises the debt ceiling – allowing the federal government to borrow money to pay its bills – the United States could default on its obligations for the first time in history, potentially tipping the nation into recession and plunging global financial markets into chaos. Biden and McCarthy have promised to avoid that outcome, despite bitter disagreements over how to satisfy GOP demands that any increase in borrowing be accompanied by steep cuts in government spending.

But the two political leaders have struggled to forge a working relationship and demonstrate any meaningful progress toward a deal. Their struggle became glaringly apparent once again starting Friday, after Republican negotiators abruptly exited lower-level talks – prompting Biden to phone McCarthy directly as he returned from his trip to Japan.

On Wall Street, traders have grown accustomed to Washington periodically flirting with disaster over the debt ceiling before reaching a deal. By the end of trading Monday, the Dow Jones Industrial Average had fallen by about 140 points, while the S&P 500 closed slightly up.

But some analysts said that sense of relative calm could soon evaporate. With the debt ceiling deadline fast approaching, investors are “probably going to start getting a little more nervous,” said Alec Phillips, the chief U.S. political economist at Goldman Sachs Research.

Earlier in the day, Treasury Secretary Janet L. Yellen repeated her warning that the “X-date” – the day Treasury reserves fall too low to cover outgoing payments – could arrive in early June, possibly as soon as June 1. In her latest letter to lawmakers, she reminded Congress that a failure to act could “cause severe hardship to American families, harm our global leadership position, and raise questions about our ability to defend our national security interests.”

Analysts at Goldman Sachs and a growing number of other financial firms say they believe the X-date may come slightly later, on June 8 or 9. That theoretically would give Congress another week to address the debt ceiling.

But the mere prospect of default could breed economic turmoil long before the Treasury Department actually runs out of cash. Among the more alarming possibilities: Fitch Ratings and Moody’s Investors Service have signaled they could place the country’s credit under review if Washington strays too close to default. In 2011, a similar standoff between House Republicans and President Barack Obama prompted S&P to lower its rating of U.S. debt, sending the Dow plummeting and ultimately costing taxpayers more than $1 billion in higher borrowing costs, according to the Government Accountability Office.

“We do expect investors’ concerns to mount as the X-date approaches, particularly if there’s no solution and the sides look wide apart,” said Jonathan Pingle, the managing director and chief U.S. economist at UBS. “As we approach, we basically see equity markets are increasingly likely to sell off, volatility indexes move higher, and there are going to be shifts and concerns in financial markets that aren’t going to be great to live through.”

Top Democratic and Republican lawmakers and aides convened for about three hours at the Capitol on Monday morning, before breaking for the day ahead of Biden’s evening discussion with McCarthy. White House liaisons Steve Ricchetti, Shalanda Young and Louisa Terrell exited shortly after noon without comment, while GOP Rep. Patrick T. McHenry (N.C.) sidestepped questions about the extent to which the two parties’ emissaries have found any common ground.

“I don’t think there’s any interest in us delaying these tough conversations,” he told reporters. “We want this to be a productive week . . . It is in my interest, and the American people’s interest, to resolve this.”

McCarthy later told reporters that the two parties “should continue meeting until we get this done,” describing the goal of the staff talks Monday as “understanding both sides.”

Before the weekend rift, a top GOP negotiator – Rep. Garret Graves (R-La.) – offered a new proposal to slash federal spending by more than $100 billion in the upcoming fiscal year and cap most agencies’ budgets through the 2030 fiscal year, according to two people familiar with the plan who spoke on the condition of anonymity to offer sensitive details. In addition to raising the debt ceiling, the proposal also called for tougher immigration enforcement on the U.S.-Mexican border, the people said.

The offer was similar to a debt ceiling bill approved by the Republican-led House last month over Democratic objections and a veto threat from the White House. This weekend, though, it proved no more popular with Democrats.

The White House countered with an offer to freeze spending in the 2024 fiscal year at the levels adopted in 2023, arguing that would represent a cut because agency budgets would not rise with inflation, according to two other people familiar with the proposal, speaking on the condition of anonymity to offer sensitive details.

Republicans rejected that idea, insisting that domestic spending must be significantly reduced from current levels so overall spending goes down in the upcoming fiscal year even as military spending goes up. Since then, the party’s more conservative members have doubled down: The House Freedom Caucus is expected on Monday to urge McCarthy to reject any offer from Biden unless it includes every provision in the House-passed bill, beefed up border security and cuts to the FBI – a new demand that follows the release of a May 12 report that was sharply critical of the agency’s 2016 investigation into former president Donald Trump’s presidential campaign.

“The Freedom Caucus will vote next week to basically accept only what we have sent to him plus what we’re adding to it,” Rep. Ralph Norman (R-S.C.), a caucus member, said in an interview Sunday.

Wall Street analysts said investors are unlikely to be fazed by the turbulent weekend, having witnessed more than a decade of showdowns that Washington managed to resolve without catastrophe. But many said the mood could shift quickly, sending markets tumbling, without signs of progress.

“My sense is that if we get toward the end of the coming week and the rhetoric is dark, we’ll see a lot more red on the screen,” said Mark Zandi, chief economist at Moody’s Analytics and a veteran observer of the debt ceiling battles. For the moment, Zandi said, “global investors are more panicked than domestic investors.”

Already, some traders have signaled their apprehensions by abandoning some Treasury bills that mature in June, around the time the government could default. Another key metric – the cost of sovereign credit default swaps, which essentially serve as insurance on federal debt – has fluctuated largely in tandem with the political outlook.

Meanwhile, some companies reliant on government spending have seen their stocks underperform by more than 10 percent this year, according to a report last week from Goldman Sachs – a sign, perhaps, that a deal to cap federal expenditures could carry market-moving consequences.

In general, Goldman Sachs analysts have found that markets are opting to “watch and wait,” a posture Phillips, the chief political economist, attributed to uncertainty over the X-date, adding: “There are a lot of people who don’t actually believe that’s the deadline.”

Some investors also do not believe that Biden can circumvent Congress. They bristled at the president’s comments Sunday about invoking the 14th Amendment to declare the debt ceiling unconstitutional, saying such a move would create significant doubts about the creditworthiness of any new debt issued by Treasury.

“What happens if the Supreme Court strikes down your interpretation of it?” said David Kelly, chief global market strategist at J.P. Morgan Asset Management.

“If there was a ruling against the administration on that, suddenly all the checks they’ve written over and above the debt ceiling would be challenged,” Kelly said. “It just opens up a lot of uncertainty.”