Now that US legislators have agreed to continue spending and avoid a government shutdown, the next issue coming up is the debt ceiling. Two years ago, it was suspended for a set period of time in order to avoid the kind of spending debates under pressure as seen over the last couple of weeks. But the ceiling is set to snap back into effect with the end of the year.
That means that starting on January 1st, 2025, the US federal government will not be able to increase its debt. It still will be able to borrow money, and has a calendar in place to auction off new bonds as part of its routine operations. But, I won’t be able to borrow more money. New Treasury issuance will be used to pay off existing obligations, but the net amount of borrowing will (theoretically) remain the same.
There’s a Lot of Accounting
But, that doesn’t mean the debt will stop increasing. The bulk of the US government’s debt is in “mandatory spending”, which are things that Congress has already authorized to be spent but hasn’t provided the means to obtain the funds. Those include health care and pensions. Also – of special interest for forex traders – interest. Just the main mandatory spending elements amount to over 53% of the government’s spending.
But, that’s fine because the government won’t immediately run out of money. As of writing, it has over $775 billion in cash, which amounts to 42% of the annual projected deficit. In other words, the US government can keep functioning for at least the next quarter, if not as far as June. And then it can start taking so-called “extraordinary” measures to conserve cash. Hitting the debt ceiling isn’t an immediate problem for the government.
Where Is the Problem
That headroom assumes continued income and spending around the same level. If Trump as President wants to enact policy that, for example, reduces tax income, then that window gets smaller. If the economy grows faster than anticipated, then the government will collect more revenue, and the window widens.
However, the main issue for forex traders is how this affects interest rates. After all, it’s the interest rate that drives the relative demand for the dollar. But, if investors start to seriously worry that the government will default, then a “risk premium” is added to the interest rate. That means the nominal rate is higher, the dollar could weaken as traders factor in the risk that the debt they are buying won’t be fully paid off.
The Interest Rate Moves
If there is a particularly fiery political debate over the debt ceiling, credit agencies could lower their rating for US debt. That would increase borrowing costs, widening the interest rate gap with other currencies, also making the dollar stronger. But, if the situation is resolved with the inevitable increase in the debt ceiling, then the extra spending will likely be deemed inflationary, also raising the interest rate.
Overall, the debate over the debt ceiling next year is likely to be one of the factors contributing to a stronger dollar, at least in the first quarter. With plenty of funding still available, the issue might be kicked forward for a month or two initially. Just like it was last time the debate came up. Then the situation would be expected to normalize.
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