A debt ceiling deal in D.C. would be good news, right?

Yes. Yes, it would. Unequivocally. Because a voluntary US default would be bad news. Unequivocally.

However, there are two potential unintended consequences, one of which got a test screening (if you will) on Wednesday, when US equities rallied hard in part because Kevin McCarthy said a deal is now “doable.”

“If we do get a debt ceiling deal, and then we do get the big risk prem / hedge unwind which then slingshots a bunch of shock market flow [as] USTs sell off, equities rip higher and out of the range and [money flows] back into risky assets again, there are two major unintended consequences of this seemingly obvious good news,” Nomura’s Charlie McElligott said Thursday.

Most readers can probably sketch the contours of those unintended consequences. The first is just that removing the left-tail risk of recession-by-default chances reigniting animal spirits, not just in markets but also across the economy.

Joanne Hsu, director of the University of Michigan sentiment survey, said last week that in addition to inflation concerns, the prevalence of negative news flow, along with debt ceiling worries, weighed on consumer psychology this month. If the debt ceiling albatross is removed, that could embolden consumers, which in turn could catalyze more spending. And then there’s the risk of a large stock rally, which could ease financial conditions and rekindle the wealth effect.

“[A] market and economic ‘sigh of relief’ risks a resumption of temporarily ‘dialed-down’ activity into the x-date concerns,” McElligott wrote, cautioning on a “‘mini-Animal Spirits 2.0’ danger,” set against a market which is “positioned for ‘pause then cut’ and absolutely not positioned for ‘pause then re-hike.'”

The second knock-on effect from a debt ceiling deal needs little in the way of editorializing. An agreement would trigger a tsunami of bill issuance, pegged at around $1 trillion by the end of Q3, which mechanically drains liquidity. When taken in conjunction with the money market fund-RRP nexus and ongoing QT, the read-through is a potentially onerous liquidity headwind.

“Regarding this liquidity drain, we already have an irritatingly slow-drip QT while money market funds and RRP both continue to sit on beaucoup,” McElligott went on, noting that in addition to the TGA rebuild, “we can add another liquidity removal in the form of a fiscal benefit running out [with] the upcoming end of the student loan payment moratorium likely coming 60 days after June 30.” All of that as banks expect credit conditions to keep tightening (per the senior loan officer survey) and Americans’ cash buffers continue to dwindle.

So, even as a debt ceiling agreement is absolutely good news considering the alternative (financial and economic armageddon), it’s prudent to think a few steps ahead, which in the current environment entails assessing the ways in which an assumed D.C. deal could manifest in “be careful what you wish for” fashion.