Debt Ceiling Marks Round Two of Budget Battle

President Obama and Congress reached an 11th hour deal on the budget on Friday night that averted am embarrassing shutdown of government services, but the battle over spending is only just beginning, according to Signe Roed-Frederiksen, a senior analyst at Danske Bank in Copenhagen.

President Barack Obama
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President Barack Obama

“Focus now turns to the much more important discussion of raising the US federal debt ceiling, which the Treasury department estimates will be reached by 16 May,” said Roed-Frederiksen in a research note.

Talks over raising the debt ceiling are expected to be as intense as those over the budget, which will again draw attention to America’s fiscal position.

“A risk premium is thus likely to be added to longer-term US yields during the negotiation process although the focus on tighter fiscal policy could work in the opposite direction,” Roed-Frederiksen said.

US Treasury Secretary Timothy Geithner has warned a failure to raise the debt ceiling would leave the federal government with no “headroom to borrow within the limit” by early July, which would have huge implications for global markets.

“The consequence would be that the US effectively defaults on its debt, which would add a significant risk premium to US government bond yields, cause severe financial problems and have major negative economic consequences as it would mean suspension of key government services including social security and Medicare benefits,” Roed-Frederiksen said.

At the start of April it is estimated that the US would need to borrow another $76 billion before hitting the debt ceiling and the Congressional Research Service predicts the US will need to raise another $783 billion before the year is out.

“Hence, there is no reasonable way that the government can manage to stay below the debt ceiling by cutting spending,” said Roed-Frederiksen.

“Some Republicans have already indicated that they want further spending cuts in order to vote for raising the debt ceiling and the risk is that the debate over the coming weeks could send the risk premium on US government bonds higher,” he said.

It is unlikely either the White House or the republican leadership would want to be seen as the reason for such a disastrous outcome, but the mood on Capitol Hill could make for another round of bitter fighting.

“Historically however, Congress has always raised the debt limit before the government ran out of cash and was unable to pay its obligations.

We believe this will be the case once again, but the coming weeks could become a high-level political game of chicken,” Roed-Frederiksen said.