Writing for Capital Matters today, Kevin Hassett notes that we could be headed for some torrid times as, once again, the U.S. approaches its debt ceiling. How the coming confrontation over raising that ceiling turns out is, for now, anyone’s guess, but markets are beginning to pay attention, and some are expecting that the pushing and shoving over the ceiling may last long enough to cause the U.S. to default on its debt, if “only” temporarily.
Unease is beginning to show up in the market for short-term interest rate bets known as Secured Overnight Financing Rate (SOFR) and Fed Funds futures, with the curve showing a pronounced change in the third quarter of this year. That’s when debt ceiling negotiations are expected to heat up as the US approaches its so-called ‘X’ date, or the drop-dead day when the federal government can no longer meet its obligations in full and on time.
The slope of the futures curve “shows that the market expects negotiations to go deep, close to what is speculated as the X date (August/September) and an avalanche of bill supply after,” says Rishi Mishra, rates strategist at Futures First Canada Inc.
Likewise, Monday’s auction of three- and six-month Treasury bills showed a marked difference in demand for shorter- and longer-dated US debt. While investors snapped up the $57 billion of three-month bills on offer, they appeared to spurn the $48 billion worth of six-month bills up for sale.
It’s possible that “bill market participants are avoiding longer-dated bills due to the combined risks of a more hawkish Fed and/or earlier-than-expected debt ceiling problems,” wrote Jefferies analysts led by Thomas Simons. “Currently we do not think that default risk intensifies until we get into August (this is a July 13 maturity), but the confidence interval surrounding the timing is extremely wide.”
While few expect the US to default on its debt for a prolonged period and politicians have a number of potential levers to pull to try to avert a debt ceiling crisis altogether, another standoff risks testing the Treasury market at a time when there are already worries over its smooth functioning…
For now, a cloud no bigger than a man’s hand, but that’s going to change.