‘Kink’ In T-Bill Curve Surges As Yellen Urges Action Over Debt Ceiling
Update (1025ET): During her weekly press conference, House Speaker Nancy Pelosi claimed that she “had several options” regarding the debt ceiling but warned that she “won’t put debt ceiling in the budget reconciliation.”
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The Treasury Department will probably exhaust its measures to avoid breaching the debt limit sometime in October, Secretary Janet Yellen said Wednesday, offering more specific guidance than she previously gave.
“Based on our best and most recent information, the most likely outcome is that cash and extraordinary measures will be exhausted during the month of October,” Yellen said in a letter to Congress.
“We will continue to update Congress as more information becomes available.”
Yellen had previously said in July that there were scenarios in which the Treasury could exhaust its special measures and run out of cash “soon after Congress returns from recess” in September.
This new projection fits with what we described as “Stealth QT” scenario 2 occurring…
As Man Group previously warned, the imminent debt ceiling clash could imply Quantitative Tightening?
At the time of writing, it’s all but certain that Congress is unlikely to raise the US debt ceiling before the Senate leaves for summer recess. The debt ceiling is the maximum amount the US government can borrow to meet its financial obligations. When the ceiling is reached, the Treasury cannot issue any more bills, bonds, or notes. It can only pay bills through tax revenues, or by dipping into its savings (i.e., the cash balance) at the Treasury.
At the end of July, the Treasury’s cash balance was only USD442 billion, a relatively low level. For context, between the end of June and end of July, the cash balance fell by USD398 billion [ZH: it has since dropped to $262 billion]
In a ‘normal’ world (where the debt ceiling isn’t an issue), the US Treasury would not have tapped into its cash balance. Instead, it would have issued enough debt to match its spending needs. Net net, this would have no impact on markets – the amount the Treasury spends (which is like a cash injection into the US economy) would be offset by the amount of debt issuance (this would take liquidity out of the system as investors would be using their cash to buy US Treasury instruments).
However, in the last few months, the US Treasury has slowed down issuance because of the debt ceiling. This, in turn, has forced the Treasury to tap into their ‘rainy day’ fund and deplete its cash balance. Because it hasn’t done much issuance to take out liquidity, net net, these actions by the US Treasury have acted like substantial quantitative easing (i.e., cash injection without the offsetting liquidity withdrawal from issuance).
Separately, the Treasury has indicated that once the debt ceiling is increased, it plans to run the cash balance at USD750 billion. This would imply that the Treasury is taking more out of the system via issuance than it is putting back into the system via spending, because it is replenishing its rainy-day fund. This acts like quantitative tightening.
In addition, there is a roughly 6-week lag between changes in the Treasury cash account and the impact on longer-dated Treasury yields (Figure 1). As such, it is possible that Treasury yields may fall further or remain at the current low levels for another six weeks or so.
If private sector market participants still have any ability to anticipate future developments, then we are likely near the point where investors begin to reduce their rates positions to make room for the increased issuance that would take place the moment the debt ceiling rollover happens. In due time, this should have an impact on asset prices that depend on long-term yields.
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The T-Bill curve is showing serious stress around this timeframe…
As the spread between October and November Bills surges…
As Bloomberg reports, Democratic lawmakers are expected to attach a measure addressing the debt limit to a stopgap spending bill that will be needed to ensure the federal government stays funded past the start of the fiscal year on Oct. 1.
Almost all Republican senators have pledged to vote against lifting or suspending the limit, tying that position to their antipathy toward Democrats’ moves to enact a $3.5 trillion package of social spending.
While this is all politics as usual, Yellen’s word choice does sound a little more nervous than we previously remember during these debacles:
“I respectfully urge Congress to protect the full faith and credit of the United States by acting as soon as possible,” Yellen
Goldman Sachs’ Alec Phillips believes there are several ways the debt limit could play out.
The most likely scenario is that Democratic leaders will attach a debt limit suspension to upcoming spending legislation to keep the federal government open past the end of the fiscal year (a “continuing resolution”) and to provide emergency disaster relief funding related to the fires in the Western US and storm damage in the East and South.
As 46 Senate Republicans have indicated they will block a debt limit increase, there is a good chance this strategy will not succeed. That said, passage of short-term debt limit might be possible as several Republican senators represent states affected by recent disasters. One option Republicans might consider would be to vote against the bill but decline to filibuster it, allowing it to pass with only 51 votes in the Senate. This would likely require unanimous Democratic support in that chamber, which is possible but not certain.
If Senate Republicans block the spending bill later this month, Democratic leaders would then need to decide whether to force the issue and risk a partial federal government shutdown, or to remove the debt limit suspension from the spending bill.
If lawmakers end in a stalemate, a government shutdown might follow, though we do not see this as the base case.
If they are unable to raise the debt limit as part of a spending bill, they might consider using the reconciliation process to pass it with only 51 votes.
However, this faces two challenges.
First, it is unclear whether all Senate Democrats would vote for a revised budget resolution that increases the debt limit by several trillion dollars. if Democrats use the reconciliation process, Senate rules would probably allow them only to raise the debt limit by a specific dollar figure, which would lead to more politically problematic headlines, rather than suspend it for a period of time, which has become the norm over the last decade as it does not lead to a specific dollar amount at the time of passage.
Second, the current reconciliation process to pass as much as $3.5 trillion in new spending is already underway, with House committees already in the process of considering and passing their segments of the bill in committee. Revising the budget resolution, which governs that process, could interfere with consideration of that legislation, and would likely take at least a couple of weeks, if not longer. If Democrats wait until Sep. 30 to test support for a debt limit increase as part of the spending bill, they might not have sufficient time to go through all of the procedures necessary to revise the resolution before the debt limit deadline.
A slightly more ominous – but nevertheless worthwhile considering – perspective:
Why not raise the debt limit you might say? Well the Fed will need to buy much of that newly issued debt but that would be a de facto tightening unless they raise QE significantly. What would be the excuse? The currency & debt markets might not take kindly to direct monetization
— Ed ☯️ The Obsolete Man…a Free Thinker (@DowdEdward) September 8, 2021
Full letter below:
Wed, 09/08/2021 – 10:04