Citigroup: Debt deal likely to include $1 trillion in cuts

U.S. lawmakers are likely to raise the nation’s debt limit by $1 trillion to avoid defaulting on its debt as part of a compromise that would include an equal amount in budget cuts, according to Citigroup Inc.

An agreement of that size would have “neglible” market impact because monthly government expenditures are about $107 billion, New York-based Citigroup Global Markets strategist Neela Gollapudi wrote in a research note to clients today.

President Barack Obama and congressional leaders are seeking an accord to increase the $14.3 trillion federal debt before Aug. 2, the Treasury Department’s projected date for expiration of its borrowing authority. Obama has told congressional leaders that he won’t sign any agreement that fails to raise the debt limit through the 2012 election.

“Republicans do not have an incentive to cede any ground,” Gollapudi wrote. “Even if small compromises are made on either side, they will be made with the expectation that the next larger portion of the deal will be made on better terms.”

It would take at least a $2 trillion debt limit increase and budget deficit cut combination to send 10-year Treasury yields lower by 20 basis points, Citigroup said.

If a deal isn’t reached, and a missed coupon payment results followed by an accompanying credit-rating downgrade, yields may rise as much as 50 basis points on shorter-maturity debt, Citigroup said. Longer-maturity debt would see only a “modest impact,” according to the firm.

“The market will likely not buy into the story that U.S. credit is impaired over the long term,” Gollapudi wrote.