The government will run short of cash to pay its bills around June 1st if a deal is not reached to raise the debt ceiling by then. They could fudge the deadline by suspending nonessential functions or prioritizing debt payments over employees’ salaries or payments to contractors.
In a pinch, the Treasury could consider other workarounds that might be legal but violate fiscal policy norms—issuing perpetuities or high-coupon bonds that raise more funds than their face value (The debt ceiling limits the face value of the federal debt, not its market value) minting trillion dollar coins, or invoking the 14th Amendment to contest the ceiling’s validity.
The standoff’s drag on the economy has been small so far, and is primarily visible in a premium of short-term Treasury rates above the federal funds rate, as well as softer consumer and small business sentiment. Prior debt ceiling standoffs caused similar headwinds, which dissipated within a few months of their resolution. But the longer this drags on, the worse the drag will become, and the greater the risk of a real crisis. Comerica’s forecast assumes Washington reaches a deal on the debt ceiling relatively soon, and that government expenditures increase slower than inflation in the next fiscal year.
CPI slowed to a 4.9% year-ago increase in April, and producer prices rose 2.3%, both the slowest in two years. Inflation is forecast to slow further into 2024 but is still well above the Fed’s target—and risks to the inflation outlook are to the upside. Surveys of inflation expectations show the typical American expects slightly more inflation over the next few years than they expected before the pandemic, but inflation expectations among the people who worry the most about it are much higher than they used to be.
After real GDP slowed from 2.1% in 2022 to 1.1% annualized in the first quarter of 2023, Comerica forecasts a modest pullback in real GDP through year-end 2023, similar to how output edged lower in the first half of 2022, but with a more substantial softening of the job market. Productivity growth has been weak since 2021 and businesses are less able to raise prices than in 2021 or 2022. That pressures margins and will likely force businesses in some industries to cut costs, including labor costs.
Fed Chair Jerome Powell stated at a monetary policy conference on May 19th that recent stresses in the financial system mean that the Fed might not have to raise interest rates as much as policymakers thought earlier this year to achieve their goals. Powell’s comments imply he favors holding interest rates unchanged at the Fed’s next decision in June.
Comerica forecasts for the Fed to hold its policy rate steady at a range of 5.00%-to-5.25% over the next few decisions. A debt ceiling crisis would likely cause the Fed to rapidly pivot to rate cuts. On the other hand, the Fed could hold its policy rate above 5% into 2024 if the economy ekes out a soft landing, the labor market holds up better than expected, and inflation surprises to the upside in the second half of 2023.
Bill Adams is a senior vice president and chief economist at Comerica. Waran Bhahirethan is a vice president and senior economist at Comerica.
