Our take on the US debt limit

Republicans have said they would agree to the extension of government funding, but only if it is delinked from the debt limit extension, which they have insisted Democrats must do by themselves (and are indeed legislatively capable of). The legislative standoff has raised fears of a government shutdown of the kind last seen in early 2019, as well as the even uglier scenario of the US potentially defaulting on its obligations – something it came close to doing in 2011. How will this standoff resolve itself, and should we be worried?

In the near term, relief should come as Democrats are indeed likely to remove the debt limit rise from the government funding bill. This will mean a government shutdown – where all but essential and emergency government services are halted – should be averted this week. The question will be a) how long government funding will be extended for this week, and b) whether Democrats will continue to insist on Republican support for the debt limit increase, if it is only a short-term extension. While Democrats are able to raise the debt limit themselves, their approach so far has insisted on Republican support, with the argument being that this is paying for many previously Republican-enacted tax and spend items. In the past, debt limit rises have been approved on a bipartisan basis, and Democrats want to avoid changing this precedent. As such, Democrats now face two options: 1) a high stakes approach that for now separates the debt limit rise from the government funding extension, but maintains pressure on Republicans to pass the two measures together in the coming weeks, or 2) a less risky but politically unpalatable climbdown, where Democrats offer a bill that extends government funding for a longer time frame (say, to December), but which then requires the party to use the budget reconciliation mechanism to raise the debt limit by themselves. Which approach they will take, we will know in the coming 48 hours, but the signs are that Democrats will opt for the less risky second approach.

As a base case, we expect both a near-term shutdown to be averted, and the debt limit to be safely raised before mid-October. As politically unpalatable as it might be to perform a U-turn, an unprecedented US debt default while Democrats are in government would be worse, even if it is believed the blame can be levelled at Republicans. In the meantime, we are likely to be in for a few weeks of legislative drama on Capitol Hill.