‘The U.S. fiscal situation is rapidly deteriorating,’ strategist says

Strategas Securities Managing Director of Policy Research Jeannette Lowe joins Yahoo Finance Live to discuss the U.S. debt ceiling, the expectations for President Biden’s meeting with lawmakers on Friday, and the outlook for discretionary spending going forward.

Video Transcript

AUSTAN GOOLSBEE: For sure, you would see interest rates going up on mortgages, on auto loans, on credit cards, a whole bunch of things that are indirectly tied to the rates on treasuries. I think you would have a lot of chaos, to say nothing of the fact that we got to pay the people in the armed forces. We got to pay Social Security. How is it going to work if we can't do that? I think there's just-- this makes no sense. They just, they have to figure it out.

- That was Chicago Fed President Austan Goolsbee in an exclusive interview with Yahoo Finance earlier in the week, warning of the risks if Congress can't lift the debt ceiling. And they haven't done it yet. President Biden and House Speaker Kevin McCarthy failing to reach an agreement yesterday as the impending June deadline creeps ever closer.

Joining us now is Jeannette Lowe, director of policy research at Strategas Securities. Jeannette, thank you for being here. I guess, first of all, I want to talk about the potential repercussions, but to sort of set the stage here, you being somebody who's close to the Beltway, seeing what's going on there in Washington-- I guess nobody knows what's in the hearts and minds of the players. But from what we can tell, do you think that they will come to an agreement before the deadline?

JEANNETTE LOWE: Well, first of all, thanks for having me. Second, so we didn't really expect much to come out of the meeting yesterday. This was kind of the first meeting after the House passed a bill. That was important because that was round one of these negotiations.

So now the principals have sat down. And they just reinforced what they were each thinking, what are their sides are. But at the same time, it's important because what we saw was two important things come out of that meeting. Number one, they instructed staff to start working today on some negotiations. And two, they set up a future meeting on Friday for the principals to meet again.

So to us, even though it doesn't seem like we made much progress yesterday, we think that we are still on a trajectory to actually get this done. It doesn't mean that there isn't some risk, doesn't mean that there couldn't still be a policy mistake. But our view has always been that this is probably going to go down to the wire. That is generally what happens in Washington. So this could be something that doesn't get resolved until the two weeks before June 1 or just the week before June 1.

And, of course, there is a risk that we could go over the X date. But we just caution that that's not really a default because the Treasury would likely have some cushion, and the Treasury would prioritize Treasury payments, so we would not actually be in a real default.

- How much cushion would we have? If we did go over the X date, June 1, when would a hard deadline then become after that?

JEANNETTE LOWE: So we think that Treasury probably has a few days. Treasury Secretary Yellen is not going to give an exact estimate of what her cushion will be, could be $25 billion, could be $100 billion. But she's probably going to give herself a little bit of a cushion so that if potentially we went over the X date, there would, A, be some time to get something still resolved because that pressure of having gone over the X date would then make policymakers move. And then second, it would give her some cushion so that she wouldn't have to worry about actually starting to prioritize government spending payments at that time.

- So tell us in concrete terms if, indeed, we pass the deadline, where there could be temporary cutbacks. And sort of break it down for normal Americans and investors. What would be the most direct and immediate effects?

JEANNETTE LOWE: So what would happen is that the treasuries would-- Treasury said in the past that they would prioritize payments on interest and principal for maturing securities. What would happen is that they would likely prioritize payments for Social Security, for Medicare, for defense, likely for veterans' care. But then they would have to make a decision about paying other bills. So that could be whether or not they pay other government contractors, whether they pay education, things like that.

But I would caution that this is a very small probability. More likely is that we think that there will be a deal. They just both have to-- sides have to save face in some way. So Biden, obviously, has been calling for a clean debt ceiling increase. Speaker McCarthy has been adamant that we need spending cuts.

They're trying to probably figure out a way where maybe we do two separate votes. Maybe we have a two-step process, where we set up a framework for spending cuts with the debt ceiling now. And that gives us a couple of months to then fill in the details. And then the debt ceiling would automatically be triggered to raise again for another period of time once we actually get those details filled in.

So I would say although there's not concern about default if we cross over the X date, that is the lowest probability. And there is still a much higher probability that we actually do get something done. I think yesterday, you did see, although there was still some tensions within that meeting, there was also some constructive statements about the fact that we would not default.

- Is it clear what both sides of the aisle are asking for as they're looking to get this debt ceiling raised or just getting the overall approval to move this forward?

JEANNETTE LOWE: Right. So Speaker McCarthy has probably three main asks. He wants to put a cap on discretionary spending going forward. He wants to pull back COVID money that has not yet been spent. And he wants to do energy permitting reform.

The Biden administration is going to put forward its priorities on energy permitting reform today. So that shows some overlap there. Obviously, the president, although he's been calling for a clean debt ceiling increase, has also intimated that he is open to budget discussions. He just wants them separate. So I think that there's still some understanding that there will have to be some austerity measures coming into play.

One of the things that's important is that we have the April budget data come out on Monday. And it shows that the US fiscal situation is rapidly deteriorating. And one of the things that we watch in particular is what is happening with net interest costs as a percentage of tax revenue. So this is because interest rates have been going up. Then it costs more for the US to service its debt.

Those costs are now 12.7% of tax revenues. We have found in the past that once they hit 14%, the financial markets tend to impose austerity on policymakers. And so something does have to happen on the budget.

Biden will also probably push for some tax credit, tax increases. So Biden had put a number of tax increases in the budget that he put out in March. We don't think large things, like an increase in the corporate tax rate or an increase in individual tax rates, would be on the table, but maybe something smaller, maybe something like an increase in the buyback tax rate, that could be something that could be on the table. But there are areas where they could find an agreement. They just also need to figure out how to structure it so probably both sides can save some face in this.

- We'll see what that ends up looking like, and hopefully it will happen. Jeannette Lowe, director of policy research at Strategas Securities, thank you so much. Appreciate it.

JEANNETTE LOWE: Thank you so much.