Celebrating Failure

So it looks as if we will have a fiscal deal. The final bill will be the result of the Senate negotiations that concluded this morning:

1.     It will reopen the government and fund it at current levels ($986 billion) to January 15, 2014.

2.     The debt ceiling will be raised until February 7, and Treasury will be able to undo the extraordinary measures that it took to extend the debt limit from May until this week. This would seem to suggest that the next debt limit showdown is set for June/July 2014 (assuming the extraordinary measures get us till mid-April, after which the seasonal factors and a possible government-sponsored enterprise, or GSE, payment should make the next few months manageable).

3.     There will be a budget negotiation (Senate-House conference committee) with a deadline of December 13, but there does not seem to be any real bite if it fails to deliver. Expectations are low, though there will still be an effort to ease the sequester for FY14 offset by future cuts.

4.     Without a deal, sequestration in January would reduce spending by about $20 billion.

5.     In addition, the agreement gives flexibility to government agencies under sequester, provides retroactive pay for federal workers, and makes inconsequential changes to the Affordable Care Act.

While overall markets have remained well anchored by the firm expectation that the United States would not default on its debt, the costs have mounted as measured by greater uncertainty and fragmentation of the money market. Still, markets want to be long, and we are seeing a solid rally on expectation of a deal.

A shutdown in January may be less likely with the sequester already in place as a fallback option, and perhaps the debt limit debate will be settled more easily in summer 2014 with the midterm elections only a few months away.  (I am surprised more attention isn’t being paid to this timing issue.)  But I do remain concerned about the structural problem caused by an uncertain and soft deadline. Our policymakers can only address these issues at the last possible moment, and when there isn’t agreement on the last possible moment—October 17, November 1 or sometime later—mistakes can happen. In particular, the recent pressures on the money market would have forced extraordinary actions from the Fed or Treasury soon, leaving a question mark over how future showdowns will be handled.

It is a win for the president and positive for markets in the sense that it’s better than no agreement, and longer in duration than some earlier proposals. But at the core, it’s a policy failure. It doesn’t address the underlying causes of the conflict, ensuring we will travel this road again.

This piece is cross-posted from Macro and Markets with permission.