What? Even reaching a debt ceiling agreement may not be good news for US stocks!

If the debt ceiling agreement cannot be reached, the US stock market will collapse and US bond yields will soar. This would be catastrophic, that's all.

This potential disaster has made investors nervous in recent weeks because Washington politicians are working hard to reach a compromise before June 1, otherwise the US Treasury will be unable to pay its bills.

But the problem is that reaching a debt ceiling agreement is not all good news for investors and the US economy.

Of course, this does not mean that the US stock market will not rebound after announcing an agreement to raise the debt ceiling and avoid default. In fact, any agreement is much better than no agreement.

But for the market, this will not be a comprehensive signal to lift the alarm, except for a short-term rebound.

Why?

Republicans are demanding significant spending cuts, while the economy seems to be slowing down at this time.

At the same time, the issuance of a large amount of government bonds after the agreement is reached will drain market liquidity and put pressure on risk assets.

Jefferies senior economist Thomas Simons said: "The debt ceiling agreement will lead to fiscal tightening."

"The current deadlock is mainly focused on cutting spending. We believe that Republicans are likely to eventually achieve the large amount of discretionary spending cuts they expect. Just like the debt ceiling collapse in 2011, we may end fiscal tightening at a very unfortunate time, when the economy is in recession."

Significant cuts in government spending pushed by Republicans may mean that economic growth will slow down after 2024, depending on the final details of the agreement.

Liquidity may tighten

After reaching an agreement, the Treasury Department will need to immediately rebuild its cash balance in its so-called ordinary account. This means that there will be a large amount of Treasury bills issued in early June, which may push up yields.

TS Lombard macro strategist Skylar Montgomery Koning wrote: "When the debt ceiling is finally raised, the amount of US debt issued will need to increase significantly: this means that about $500 billion will exit the economy and enter the Fed's US bond account."

"This means that liquidity will tighten, unless private credit demand drops significantly at the same time (which seems unlikely)."

Government data shows that since reaching the debt ceiling in January, cash in the ordinary account has decreased by more than $500 billion. This offsets the quantitative tightening (QT) plan that the Fed is implementing, which includes purchasing $60 billion in Treasury bonds every month.

Rebuilding this account will be another move after QT, which will exacerbate the liquidity drought in the US economy. This is a major disadvantage for risk assets.