The political limits of rising interest rates

Oct 24, 2022

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White House officials are facing a hard post-election truth: If the U.S. economy goes into a recession next year, the government may be hard-pressed to help much.

The constraints are twofold, Marc Goldwein, senior vice president at the Committee for a Responsible Federal Budget, tells your MM host . Rising interest rates are sending the government's debt costs soaring, eating up a bigger share of the federal budget and adding to its bottom line. Despite a record decline in the deficit in fiscal 2022, net interest payments climbed to $475 billion, a 35 percent increase. And they're expected to keep rising.

It's primarily a political constraint: Even if there's still healthy investor appetite for U.S. debt, the rising costs will no doubt make it harder for lawmakers to get on board with more borrowing, Goldwein said.

The second constraint is economic: A big burst of deficit spending — the kind policy makers have deployed in previous downturns to cushion the economy — could fuel inflation, making it harder for the Federal Reserve to tame price pressures.

From your MM host: "As a practical matter, it means government spending, from big agenda items to possible support for struggling households, would need to be offset with tax increases or spending cuts, not more borrowing, a colossal hurdle even when the president's party controls both chambers of Congress."

White House officials said they're not concerned — the president has always proposed that his policies be paid for, and nothing has changed that view. They also don't see the U.S.'s fiscal space, or borrowing capacity, as having narrowed much, if at all, in the long run.

But what will markets think? Planned tax cuts for the wealthy, announced by U.K. officials last month, prompted a market meltdown that forced the Bank of England to step in to buy government bonds and led to Prime Minister Liz Truss resigning just six weeks into her tenure.

"The lesson of the U.K. is, markets are going to be much more vigilant about any fiscal plan in this environment, particularly for countries that have a large debt stock that are potentially going into an economic downturn and are seeing interest rates move substantially higher," said Daleep Singh, chief global economist at PGIM Fixed Income and a former deputy director of Biden's National Economic Council. "You have to be really careful."

IT'S MONDAY — We're rested and ready for GDP, PCE and whatever other acronyms this week throws our way. Have a tip, story idea or feedback to share? Let us know: kdavidson@politico.com and ssutton@politico.com .

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Driving the Day

S&P manufacturing and services PMIs released at 9:45 a.m. … Treasury Secretary Janet Yellen speaks at the SIFMA annual meeting at 11 a.m., followed by SEC Chair Gary Gensler at 12:50 p.m. and CFTC Chair Rostin Behnam at 1:40 p.m. … Consumer confidence index released Tuesday … International trade and new home sales data released Wednesday … First estimate of third-quarter GDP released Thursday … Inflation and consumer spending data released Friday … University of Michigan consumer sentiment index released Friday.

HAPPY MONDAY — The insurance and asset management firm AXA's annual global survey identified climate change as the greatest single threat facing the world. It's the first time in its nine-year history that climate was identified as the primary risk in every single geographic area surveyed, with geopolitical and cybersecurity dangers also scoring high. "The report confirms a trend that has been evident for years: an increase in the general feeling of vulnerability, and erosion of confidence in the ability of institutions to find sustainable solutions," CEO Thomas Buberl said in a statement. "In fact, I see this as the greatest risk that threatens us: the feeling of powerlessness."

FIRST IN MM — GOLDMAN SACHS WANTS SBA ON THE AGENDA — With the midterms approaching, Goldman Sachs – through its 10,000 Small Businesses Voices – says it's ramping up pressure on midterm election candidates to outline specific policies that will aid small businesses. The bank's small business program released a policy wishlist earlier this year that urged lawmakers to reauthorize the Small Business Administration, approve or renew tax credits and revive pandemic-era lending programs.

GDP WEEK — The first estimate of third-quarter GDP comes out Thursday at 8:30 a.m.

"The U.S. economy is expected to have grown robustly in a sharp rebound from the first half of the year," WaPo's Abha Bhattarai writes, "but most Americans are unlikely to notice anything about the turnaround. …

"'This is going to look better than the previous two GDP reports, but conditions on the ground haven't changed very much,' said Douglas Holtz-Eakin, president of the American Action Forum and a former director of the Congressional Budget Office."

Meanwhile, from FT's James Politi and Colby Smith: "Joe Biden's top economic adviser [National Economic Council Director Brian Deese] said the US economy had the 'strength and resilience' to shield it from a recession , brushing off growing concerns that steep interest rate increases designed to fight inflation will quash the expansion."

CAN'T FIGHT THE CEILING — President Joe Biden on Friday said he "will not yield" to GOP demands to cut spending or face a standoff over the debt ceiling next year, our Adam Cancryn reports. But he also ruled out eliminating it entirely, saying such a move would be "irresponsible."

Regulatory Corner

HOUSING PUNT — Our Katy O'Donnell: "A government-run housing agency has backed off on plans to force mortgage lenders to shore up their capital buffers in the face of a potential recession after industry officials warned that the move could instead roil the market."

IRS LIMITS — Our Brian Faler: "People will be able to squirrel away more money next year in tax-preferred retirement accounts thanks to inflation. The IRS announced Friday that the lid on contributions to 401(k) retirement accounts will climb next year to $22,500, a $2,000 increase."

Speaking of the IRS: "With less than three weeks left in Charles Rettig's term as Internal Revenue Service commissioner, President Biden hasn't picked anyone to replace him , leaving the tax agency without a leader to spearhead the $80 billion agency expansion that Democrats just pushed through Congress," WSJ's Richard Rubin reports.

Economy

A REAL NAIL-BITER — WSJ's Tom Fairless: The world's central banks "have raised interest rates this year at the fastest pace in decades. But those hikes work with what economists call 'long and variable' lags so central banks might not know for years if they have tightened too much, or not enough."

Markets

EARNINGS SEASON? MEH — WSJ's Paul Berger: "Early results from the third-quarter earnings season haven't provided much comfort to jittery investors . While some corporate leaders noted glimmers of hope for consumers and the economy, many have reported a host of challenges to profits, including persistent inflation, rising interest rates and a generational surge in the dollar that has pressured revenue generated overseas."

WALL STREET CHIEFS HEAD TO SAUDI SUMMIT — Bloomberg's Matthew Martin: "An escalating dispute over an OPEC+ decision to cut oil production risks causing lasting damage to political relations between the US and Saudi Arabia. Wall Street seems unfazed .

"JPMorgan Chase & Co. CEO Jamie Dimon and Goldman Sachs Group Inc.'s David Solomon are among US finance chiefs preparing to attend Riyadh's glittering investment summit this week, a showcase for Saudi Crown Prince Mohammed Bin Salman."

JOIN WOMEN RULE THURSDAY FOR A TALK WITH DEPARTING MEMBERS OF CONGRESS: A historic wave of retirements is hitting Congress, including several prominent Democratic women such as Illinois Rep. Cheri Bustos, House Democrats' former campaign chief. What is driving their departures? Join POLITICO on Oct. 27 for "The Exit Interview," a virtual event that will feature a conversation with departing members where they'll explain why they decided to leave office and what challenges face their parties ahead. REGISTER HERE .

Fly Around

Goldman Sachs's decision this week to pull back from retail banking followed disagreements over strategy that in one instance pitted chief executive David Solomon against his subordinates, people familiar with the matter said. — FT's Joshua Franklin

The fall of Truss, Britain's prime minister for just six tumultuous weeks, has plunged the nation into another phase of economic uncertainty . — NYT's Eshe Nelson

Nasdaq has put the brakes on IPO preparations of at least four small Chinese companies while it investigates short-lived stock rallies of such firms following their debuts, according to lawyers and bankers who work on such stock launches. — Reuters' Echo Wang

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