The prospect of a fight over the debt ceiling is not something to look forward to. However, up to now, there have (mainly) been two working assumptions providing a degree of comfort to the markets. The first has been that “something” would be worked out before disaster struck. The second has been that the crunch could be put off (probably) until August.
That timetable was by no means certain, but there are increasing worries that the reckoning may be in June.
The Financial Times notes a new report from Goldman Sachs:
While the data are still very preliminary, weak tax collections so far in April suggest an increased probability that the debt limit deadline will be reached in the first half of June. We have been projecting that Treasury could operate without a debt limit increase until early August.
At this point we see a slightly greater chance that the deadline is in late July, but this could easily change to a base case of early June if tax receipts continue to undershoot. The probability of the deadline falling between these dates is much lower, as a mid-June tax deadline will create some room under the limit and additional “extraordinary measures” become available on June 30.
So, if the date does shift to a significantly earlier date, what then?
Back to Goldman:
A June deadline would raise the possibility of a short-term extension. We are generally skeptical of reports that congressional Republicans might pass a short-term debt limit extension, as voting to raise the debt limit twice is harder than voting once. That said, if the Treasury announces in May that the deadline is only a few weeks away, there would be little time to negotiate a deal and a short-term extension could provide a way out. While not our base case, a June deadline would make a short-term extension a plausible scenario.
Not a lot of certainty there, which is not unsurprising. The more we know about tax receipts, the clearer (a relative term) the short-term outlook becomes.
The FT’s “conclusion”:
The debt ceiling drop-dead has probably moved forward to late July, but there’s now a chance that it arrives in early June, as the mid-month tax payments fizzle and fail to create a bit of extra breathing room.
The writer of the story links to an earlier piece by Ajay Rajadhyaksha, global chair of research at Barclays:
In the previous 2011 and 2013 debt ceiling fights, Treasury and the Federal Reserve publicly set out a series of principles they would follow in case of a debt limit impasse. The first was that Treasury would prioritise bond payments.
Officials would forecast future bond interest and principal cash flows and pay bondholders before paying (some of) the nation’s other bills. Where needed, they would hold back a cushion to ensure that they could definitely make any future bond payment. In other words, a debt ceiling impasse doesn’t mean a default on Treasury bonds.
No Treasury secretary is ever going to emphasise this debt prioritisation, since it reduces pressure on Congress to raise the debt limit. Moreover, prioritisation sets a very poor precedent, and not just because of the optics of paying bondholders (including foreign nations) over US citizens and businesses.
The approach hasn’t ever been tested and would be operationally complex…
I’d pay attention to that last sentence. If you have an FT subscription it’s worth reading the rest of what Rajadhyaksha has to say. Much of it rests on a paradox. If the “day after” is managed (and can be managed in the way he suggests) that might remove the pressure to come to a speedy resolution. After all, a business waiting for a payment from the government will be pretty confident that the money will ultimately come through, and if the holders of government debt (which, incidentally, will include money-market mutual funds, and, indirectly, investors in those funds) also keep calm, those charged with resolving the impasse might feel that they can relax.
They cannot.
Rajadhyaksha:
[I]f days turn to weeks and that payment still doesn’t show up, the owner might struggle to make payroll. Even worse, if they start to wonder if the payment will ever arrive, the business might pull back hard. But this process is a slow build. On the day after the drop-dead date, most non-bond creditors of the US government are likely to think of the process as a payment delay of a few days, not a default. The greater the time that passes since, the more the chance that something “breaks” in the economy.
Financial markets will also follow this logic…
The current proposal being floated by Speaker McCarthy may or may not be a worthwhile political maneuver, but it’s not going to become law. My guess is that because the stakes are so high, some sort of majority will be cobbled together to raise the ceiling. The only question (and it’s quite some “only”) is how long that will take.
And yes, the stakes are high.
This, by John Cochrane in January, is worth noting:
If we are to tussle over paying Wall Street fat cats vs. grandma’s social security, keep in mind just what a catastrophe default would be. Grandma will be way worse off if that happens. Treasury debt is now the golden collateral, supporting most of the financial system. (We should have a financial system much less dependent on short term collateralized borrowing, but that’s another story.) If in default it would not be. Worse, and most important here, if financial markets suspect a default will really happen, they will start refusing to accept treasury collateral in the first place. This is basically what happened in 2008 with mortgage backed securities. They didn’t fall to pieces, they just weren’t acceptable as collateral any more.
A flight from treasury collateral under a debt limit would be far worse. And the government’s magic tonic, borrow a ton and bail everyone out, would be unavailable.
Perhaps Treasury thinks that by threatening default, they can get Congress to wake up and raise the debt limit promptly. But this risks Wall Street also believing the threat and causing the panic you’re trying to prevent.
Treasury secretary Janet Yellen should say out loud, right now “we pay principal and interest on treasury debt first, before anything else.” President Biden should back her up. Drastic delays in social security, medicine, government shutdown and more are plenty enough threat to get Congress to move, without risking a run.