U.S. Debt Deal with a Twist—Details of the Fiscal Responsibility Act

Last Edited by: LPL Research

Last Updated: June 07, 2023

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Summary:

U.S. Debt Deal with a Twist

In what has become a near annual ritual, the U.S. Congress passed and President Biden signed what is known as the Fiscal Responsibility Act, which is legislation that again raises the U.S. debt ceiling and averts the risk of a U.S. default.

In this latest edition of LPL Street View, we’ll cover the basic details of the deal and highlight some potential ramifications of the extenuating steps the Treasury took to pay the U.S.’ bills while political leaders negotiated.

What’s in the debt ceiling deal…?

The new deal suspends the U.S.’ current $31.4 trillion borrowing limit until January 2025—this conveniently gets both parties past the 2024 election. The new debt limit in January 2025 will be set at whatever debt level is reached when the suspension ends.

The legislation call for cuts in non-defense discretionary spending in 2024. While those cuts are not exactly clear, some of the provisions include plans to rescind $28 billion in unobligated funds from COVID-19 relief packages. In 2025, discretionary spending growth can resume with no more than a 1% increase from 2024 levels. 

In 2024, military spending will increase from a budgeted $773 billion in 2023 to $886 billion and increase again to $895 billion in 2025. The legislation will also end the freeze on student loan repayments by the end of this summer and will claw back $10 billion in IRS funding. The IRS budget in 2022 was approximately $14 billion, although the previously passed Inflation Reduction Act had legislated an additional $80 billion in IRS funding over 10 years, thus a $10 billion claw back is only a small portion of the new IRS funding. 

Finally, the legislation included agreements on new measures to get energy projects approved more quickly by restricting environmental review periods.

So what’s the “Twist” we mentioned in the title of this video? 

The twist is that since January, when the U.S. hit its debt ceiling, to keep the government running, the Treasury has spent approximately $400 billion in funds from its general account that had no tax or debt offset, essentially adding a $400 billion injection of liquidity into the economic system.

We believe the Treasury will have to rebuild its general account and will likely turn to raising debt to refill the piggy bank. This could effectively drain the previous liquidity build from the system and could have a bit of a dampening effect on some risky asset prices. 

Stocks have run up in anticipation of a debt deal. Now that the deal is done and some stocks, particularly tech stocks, look a bit overbought, we would not be surprised to see the market suffer a modest sell-off in the near-term. While we are still constructive on equities, much of the market return we had anticipated for this year has already been logged. With the S&P 500 Index already up 12% in 2023, less robust equity returns may be likely for the second half of the year.

Thanks for listening and as we always say at LPL Research—allocate wisely.

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