The US Treasury market is one of the largest and most liquid in the world, where investors from ordinary Americans to the governments of China and Japan go to buy the debt of the federal government.
Lately, it has also been one of the most volatile as the Federal Reserve raised interest rates to their highest levels since disco ruled the radio dial. Yields between various maturities, or the amounts that government bonds pay out over time, are inverted – meaning investors are being paid less to own a 10-year bond than they are a six-month bill. That’s often a sign of an impending recession, as the economy is perceived to be more perilous in the short term than further out on the horizon.
But there’s something else rattling the Treasury market: fear about what Washington may do to ensure the government continues to pay its debt.
The federal government technically reached the statutory limit of its borrowing power back in January, the $31.4 trillion debt ceiling beyond which it cannot raise more money to pay its existing bills. However, the Treasury Department is using “extraordinary measures” to keep things going, curtailing some payments into government retirement plans and other moves that have bought some time.
The Week in Cartoons March 13-17
How much time? That is a matter of some debate, but there is a general agreement that the “x” date when these measures will not be enough is going to fall somewhere between June and September. Exactly when it is hard to pin down as it depends on how much money is coming into the government through taxes and other sources of revenue. At best, the dates are based on projections that may or may not prove to be accurate.
To debt holders, that can be unnerving. If the government does default, something has never been done, or even if payments are delayed or prioritized (meaning some people get paid and others don’t, or not as quickly) it could leave bondholders in the lurch. Or credit-rating agencies could downgrade the US government’s creditworthiness, making it more expensive to borrow in the future.
“We lifted the debt limit. We’ve sent it to the Senate. We’ve done our job,” McCarthy said after passage.
Now the fun begins. The Senate considered the bill a non-starter and the White House issued a statement saying, “President Biden will never force middle class and working families to bear the burden of tax cuts for the wealthiest, as this bill does. The President has made clear this bill has no chance of becoming law.”
Some sense of how the bond market is viewing things can be seen in the performance of the one-month Treasury bill, a short-term instrument that is widely used to park cash that may be needed for investment or for redemptions from money-market funds and other short-term accounts.
At the end of March, the one-month was yielding 4.704% but as of Thursday, that had fallen to 3.795%. The three-month Treasury, by contrast, has gone up to a yield of 5.14% from 4.8% at the end of March.
“Every MMF (money market fund) and DIY (do-it-yourself investor) is making the same tradeoffs and the easiest decision is to buy bills that will mature well in front of the D-Day for the debt ceiling,” Andy Constan , who has spent more than three decades at top investment firms and now runs the macroeconomic research firm Damped Spring Advisors, tweeted in mid-April.
Wells Fargo economists recently updated their January analysis of the debt ceiling debate and now put the “x” date closer to the start of August.
“In our view, an X date in early August is still the most probable outcome. More specifically, the first three days of August seemed most likely to contain the X date,” they wrote.
One complication is that tax revenues have been coming in below forecast after an unusually strong 2022. Balances at the Treasury’s bank account at the Fed have also been volatile of late. After hitting nearly $1 trillion in May 2022, they fell to less than $90 billion in March but have since rebounded to $265 billion as 2023 tax payments came in.
Most observers predict the two sides will wrangle for political points ahead of the “x” date, and that is a script that has happened before. But there is a cost to that, as the country found out in 2011 when the standoff went to the wire before the ceiling was lifted in exchange for future budget cuts. Stocks sold off sharply, the S&P 500 fell 17%, and bond yields rose in the run-up to the final deal. Afterward, various reports pegged the cost of delaying the increase at $1.3 billion in higher borrowing costs to the government.
For now, market watchers tend to be only modestly concerned about the possibility of a default, many having seen the same scenario play out in Congress over the years.
“It’s going to be psychological more than anything,” as the date gets closer and the rhetoric heats up, says Gene Goldman, chief investment officer at Cetera Financial Group. “It’s going to be 2011 all over again, waiting until the last second.”
But there is a catch. The political environment is different now, with a core group of members of both parties, less dependent on party leaders and more willing to go it alone on social media and cable TV where their constituents hang out.
That is especially true now as both the leading candidates for the 2024 presidential election – Joe Biden and Donald Trump – are deeply unpopular with the general public. Democrats enjoyed an unprecedented set of legislative victories in their first two years of control of the White House and Congress. But with the House now held by Republicans, the dynamics have changed.
“We believe that the consensus underestimates the risk of US debt default because consensus views rely on the historical record and political polarization has worsened since the debt ceiling crises of 2011 and 2013,” warned BCA Research in a special report this week. “The two US political parties today are even more antagonistic.”