Debt ceiling debacle: Biden, McCarthy look for deal to avoid default

Jeannette Lowe, Strategas Securities Managing Director, Policy Research, and Steve Sosnick, Interactive Brokers Chief Strategist, joins Yahoo Finance Live to discuss what happens if debt ceiling negotiations aren't resolved before the due date, including the major impact it could have on the market.

Video Transcript

- Today could be the day. It probably won't be. Then we'd been saying that for weeks. At this point, we're talking about the debt ceiling. President Biden returns from a busy G7 summit with a meeting with House Speaker Kevin McCarthy, top of his to-do list.

The Speaker says, any deal could be voted on in the House this week. This amid another warning from the Treasury Secretary Janet Yellen. She told "Meet the Press" the chances the government can pay all of its debt by mid-June are quote, "quite low."

Joining us for the conversation, Jeanette Lowe, Strategas Securities Managing Director for Policy Research. And also, with us for the first half of the show, at least today, Steve Sosnick, Interactive Brokers Chief Strategist going to be hanging out with us.

Jeanette, I do want to start with you because we're getting closer to June 1, which is that date that the Treasury Secretary has floated. What happens after June 1st, if there's no deal? What measures? What things start to not get paid by the government?

JEANNETTE LOWE: Well, thank you for having me. So just as a reiteration, June 1 is the X-date. There is usually a little bit of wiggle room to that date. So the Treasury tries to have a buffer in place. So that if we were to cross the X-date, that would really put pressure on policymakers to then actually get a deal. Now, there is some talk about whether or not June 1 is the actual X-date or maybe it's going to be a little bit more like June 7 or June 8.

But the risk is that we've seen tax revenues come in weaker in May. And so the risk is that June 1 is more likely to date than even a little bit later. But as Yellen said, if we don't make it to June 15, we don't get those quarterly tax payments. And that makes it a little bit more difficult to actually have enough cash to pay all of our bills.

But the Treasury Secretary also yesterday pretty much insinuated that there would be no real default. So we would continue to make principal and interest payments on treasuries. But then it would be more about a prioritization of other government spending. So we are of the view that the Secretary would prioritize things like Social Security and Medicare and defense. But may have to maybe withhold payments to government contractors.

And that's where you could see a risk. And I think that's where you see some risk in some of the names that are tied to that as well over the past couple of weeks.

- Steve, it looks like you had a response of reaction to that as well.

STEVE SOSNICK: Well, my point would be June 15, I know I've got to pay some estimated taxes. And I think some other people must. And so the question would be, if we make it to June 15, do we then get a bit more breathing room because of the estimated tax payments?

- Jeanette, what do you think?

JEANNETTE LOWE: So we would. If we actually made it to June 15, we would have a little bit more breathing room. And then the Treasury Secretary would actually have a few more extraordinary measures that would then kick into place on June 30, which means we could potentially get into July.

However, I think all of the negotiators are focused on June 1. Yellen was out yesterday trying to also continue to put pressure for a deal by June 1. We do think it's more likely that you're going to see a deal before then rather than not.

Biden is back from Japan. That's important. So he and McCarthy can sit down this afternoon and try to finalize a deal. You do continue to see that while there was a lot of dourness over the weekend and on Friday when the talks were paused. At the same time, you're also seeing that they are getting much more into the weeds. And so this isn't talking totally from the corners. They're really digging into the budget. They're trying to find ways where they can actually fill holes and make sure this spending has some caps into it.

But then also trying to protect key programs. So I think that that's important. It's just about really getting into these last details. And we could potentially still see a deal this week at some point.

- Are there specific sectors or even industries that you think about, Jeanette, that have some heightened exposure even as these negotiations continue to take place?

JEANNETTE LOWE: Absolutely. So what we've been highlighting is that there's a number of defensive names that what we were looking at. Even in the 2011 debt ceiling debate, you saw certain defensive names outperform, whereas, other names underperformed leading into those debt ceiling negotiations. And then heading out into the rest of the year.

At the same time too, you see things like defense names and other health care names that are tied to government spending. They've really been weak. They've actually been weak since January with the Speaker's fight over the vote over the Speaker just because that portended that we were going to have a debt ceiling talk over spending cuts. So there is risk there that some of these names are worried that they could see cuts going into the debt ceiling.

But then the other thing I think that's important is we're talking about definitely having some spending cuts and caps in this deal. So our view is that they can find a deal, perhaps capping discretionary spending at current year levels into the next year. And then putting small caps on how much spending can then grow over the next several years. So that portends that we're going to go into this period of austerity.

And the same thing happened in 2011. You had $2 trillion of spending cuts that were attached to that debt ceiling deal. You actually saw the market fall after the deal was announced because the market had to reprice for those spending cuts and for lower economic growth. I think we're looking to see if we could see something similar this time around.

Remember, we are-- obviously, the US economy is slowing as we move into the second half of the year. And so you have lower potential for economic growth. And you have spending cuts on top of that. And we might potentially have a liquidity drain from the Treasury Department and no longer spending down the Treasury general account. So all of these things set up for more of a defensive positioning this second half of the year.

- What do you think, Steve? What's going to happen?

STEVE SOSNICK: Well, it is, in many ways, what Jeanette's talking about, is reverse Keynesian economics. As you're going into a recession, that's when you want to be expanding your fiscal policy, not necessarily shrinking it. And so you do have this headwind, which so far the market's relatively ignored, which is if you have fiscal policy going in reverse, and we know we have monetary policy going in reverse, those are some major headwinds.

I think it's quite impressive that we've managed to steer forward through them. But that definitely adds to the risk for the second half, if there are these spending cuts that do come through.

- And you think the market is ignoring that possibility at this point.

STEVE SOSNICK: I think the bond market is noticing. I think the bond market-- if you look at Treasury bills, there are some weird little kinks in the curve around some of the dates that may be in trouble. But the stock market, everybody's talking about it. But nobody's really doing anything about it, with the exception of the specific sectors that Jeanette mentioned.

- Go ahead.

- So just adding on to that and some of the specific sectors. Did you jive with those same sectors? Or would there be other ones that you're keeping an eye on?

STEVE SOSNICK: Well I think right now, the market's right. Because if you're an analyst who's focused on those specific sectors that are more dependent upon government payments, this has been on your radar for some time. And this is a clear and present concern. But if you're just chugging along in the NASDAQ 100 winners, you don't really see that. But that's where the broader issues come in about-- you've already been fighting monetary policy successfully. But now, do you want to add a regressive fiscal policy into that picture that you're trading?

- And so the question that you asked in a recent piece is the VIX too high or too low? What's the answer to that?

STEVE SOSNICK: I think I said in that one, if it was a high school debate, and I could be assigned to either side, I could give you an answer for either one. From the people who say it's too high, well, the historical volatility, we haven't had volatility. So traders usually start with their volatility estimates being the historical. We haven't moved in the last 10 days, 30 days, et cetera. So VIX is relatively high for that.

If we really think a crisis is coming, VIX is way low. Because we know that VIX takes the stairs to the basement and the elevator to the roof. And just the first week in May, we went from 15 half to 21 half in like, three days in VIX. So the risk is to the upside, I think, in VIX.

- And Jeanette, just to put a pin in this conversation with you, at this point, how are you gaming it out? Do you think that they're going to get there before June 1?

JEANNETTE LOWE: We do. We think that they ultimately will get there. There is definitely-- you can hear in their statements that no one wants to actually cross over the X-date and risk a default even as I mentioned earlier, actually wouldn't be a real default.

So there is definitely an effort to get a deal done. I think having the people in the room, the teams in the room now getting down to the wire is going to be the key to actually finally figuring out what are the last key pieces that need to fall into this. But we are anticipating that there will be some spending caps over a couple of years, discretionary spending caps.

We anticipate that there will be some rescission of COVID funding. We anticipate that there will be energy permitting reform. There will be work requirements probably put into the TANF program. And then, potentially, one or two other items as they're trying to fill this hole and to figure out a final deal.

But I think, again, as I said earlier, the fact that they are actually talking quite in the weeds about this, it seems to portend that we could get a deal. And even though, obviously, it would have been better to have a deal yesterday, that doesn't mean that Congress still can't get it across the finish line very quickly. And I think everyone will ultimately try to avoid any more talk about default.

- Jeanette Lowe and Steve Sosnick, both of you, please stay with us for a hot second here.